1
EXHIBIT 99.1
2
Independent Auditors' Report
The Board of Directors
First Charter Corporation
We have audited the accompanying supplemental consolidated balance sheets of
First Charter Corporation and subsidiaries (the "Company") as of December 31,
1997 and 1996, and the related supplemental consolidated statements of income,
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1997. These supplemental consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these supplemental consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
The supplemental consolidated financial statements give retroactive effect to
the merger of First Charter Corporation and HFNC Financial Corp. on September
30, 1998, which has been accounted for as a pooling-of-interests as described
in Note 21 to the supplemental consolidated financial statements. Generally
accepted accounting principles proscribe giving effect to a consummated
business combination accounted for by the pooling-of-interests method in
financial statements that do not include the date of consummation. These
financial statements do not extend through the date of consummation. However,
they will become the historical consolidated financial statements of the
Company after financial statements covering the date of consummation of the
business combination are issued.
In our opinion, the supplemental consolidated financial statements referred to
above present fairly, in all material respects, the financial position of First
Charter Corporation and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally
accepted accounting principles applicable after financial statements are issued
for a period which includes the date of consummation of the business
combination.
KPMG Peat Marwick LLP
Charlotte, North Carolina
December 18, 1998
3
FIRST CHARTER CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
December 31,
- --------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996
- --------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks...................................... $ 35,392 $ 36,529
Federal funds sold........................................... 8,195 25,946
Interest bearing bank deposits............................... 15,143 18,777
Investment securities held to maturity, fair value of
$13,979 in 1996......................................... -- 13,940
Securities available for sale, cost of $306,528 in 1997
and $316,635 in 1996 ................................... 315,565 325,825
Loans ...................................................... 1,267,061 1,127,968
Less: Unearned income................................... (5,570) (5,517)
Allowance for loan losses......................... (15,263) (14,140)
-----------------------------------
Loans, net.............................................. 1,246,228 1,108,311
-----------------------------------
Premises and equipment, net.................................. 26,057 24,053
Other assets................................................. 26,061 19,796
-----------------------------------
Total assets........................................ $ 1,672,641 $ 1,573,177
===================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits, domestic:
Noninterest bearing demand.............................. $ 103,005 $ 103,353
Interest bearing........................................ 956,257 910,343
-----------------------------------
Total deposits...................................... 1,059,262 1,013,696
Other borrowings............................................. 350,079 309,895
Other liabilities............................................ 19,391 16,805
-----------------------------------
Total liabilities................................... 1,428,732 1,340,396
-----------------------------------
Shareholders' equity:
Common stock - no par value; authorized, 25,000,000 shares;
issued and outstanding, 19,068,298 shares in 1997
and 18,996,991 shares in 1996........................... 139,712 133,241
Unearned ESOP and unvested restricted stock.................. (21,234) (23,138)
Retained earnings............................................ 119,899 117,039
Unrealized gains on securities available for sale, net.. 5,532 5,639
-----------------------------------
Total shareholders' equity.......................... 243,909 232,781
-----------------------------------
Total liabilities and shareholders' equity.......... $ 1,672,641 $ 1,573,177
===================================
See accompanying notes to consolidated financial statements.
4
FIRST CHARTER CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
- ---------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
Interest income:
Loans................................................ $ 100,921 $ 90,545 $ 76,913
Federal funds sold................................... 1,012 1,102 2,557
Interest bearing bank deposits....................... 795 908 608
Securities available for sale........................ 19,581 23,109 13,070
Investment securities held to maturity............... 821 707 5,061
-------------------------------------------------
Total interest income............................ 123,130 116,371 98,209
-------------------------------------------------
Interest expense:
Deposits ............................................ 46,332 44,708 45,699
Federal funds purchased and securities
sold under agreements to repurchase.............. 7,689 7,790 1,456
Federal Home Loan Bank and other borrowings.......... 8,806 4,918 689
-------------------------------------------------
Total interest expense........................... 62,827 57,416 47,844
-------------------------------------------------
Net interest income.................... 60,303 58,955 50,365
Provision for loan losses................................. 2,684 1,481 2,328
-------------------------------------------------
Net interest income after provision for loan losses.. 57,619 57,474 48,037
-------------------------------------------------
Noninterest income:
Trust income......................................... 1,901 1,490 1,556
Service charges on deposit accounts.................. 4,116 3,496 3,114
Insurance and other commissions...................... 959 701 494
Securities available for sale transactions, net...... 5,694 306 19
Investment securities transactions, net.............. -- -- (29)
Other................................................ 2,412 2,163 1,971
-------------------------------------------------
Total noninterest income......................... 15,082 8,156 7,125
-------------------------------------------------
Noninterest expense:
Salaries and fringe benefits......................... 21,721 20,070 15,356
Occupancy and equipment.............................. 5,436 4,448 3,658
Other ............................................... 15,608 14,651 12,803
-------------------------------------------------
Total noninterest expense........................ 42,765 39,169 31,817
-------------------------------------------------
Income before income taxes ...................... 29,936 26,461 23,345
Income taxes ............................................ 10,765 9,028 7,467
-------------------------------------------------
Net income....................................... $ 19,171 $ 17,433 $ 15,878
=================================================
Net income per share:
Basic............................................ $ 1.06 $ 0.95 $ 0.95
Diluted.......................................... $ 1.03 $ 0.94 $ 0.94
Weighted average common and common equivalent shares:
Basic............................................ 18,154,131 18,301,085 8,779,066
Diluted.......................................... 18,697,448 18,586,086 8,846,355
See accompanying notes to consolidated financial statements.
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FIRST CHARTER CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Unearned Unrealized
ESOP and Gains on
Common Stock Unvested Securities
---------------------- Retained Restricted Available for
(Dollars in thousands) Shares Amount Earnings Stock Sale, net Total
- -----------------------------------------------------------------------------------------------------------------------------------
First Charter Corporation................... 7,076,165 $ 39,553 $ 15,013 $ -- $ (474) $ 54,092
HFNC Financial Corp......................... -- -- 79,322 -- 2,490 81,812
-----------------------------------------------------------------------------------
Balance, December 31, 1994................. 7,076,165 39,553 94,335 -- 2,016 135,904
Net income for 1995......................... -- -- 15,878 -- -- 15,878
Cash dividends.............................. -- -- (2,618) -- -- (2,618)
Proceeds from issuance of common stock ..... 9,799,725 168,438 -- (9,000) -- 159,438
Purchase and retirement of common stock.... (40,781) (567) (61) -- -- (628)
Shares released from ESOP and restricted
stock trusts............................ -- 125 -- 300 -- 425
Stock options exercised and Dividend
Reinvestment Plan stock issued.......... 43,614 577 -- -- -- 577
Pre-merger transactions of pooled bank...... 247,352 2,632 -- -- -- 2,632
Unrealized loss on securities
available for sale, net ................ -- -- -- -- (532) (532)
-----------------------------------------------------------------------------------
Balance, December 31, 1995.................. 17,126,075 210,758 107,534 (8,700) 1,484 311,076
Net income for 1996......................... -- -- 17,433 -- -- 17,433
Cash dividends.............................. -- -- (5,730) -- -- (5,730)
Purchase and retirement of common stock .... (22,858) (486) -- -- -- (486)
Shares released from ESOP and restricted
stock trusts............................ -- 221 -- 300 -- 521
Stock options exercised and Dividend
Reinvestment Plan stock issued.......... 88,057 1,390 -- -- -- 1,390
Pre-merger transactions of pooled bank...... 205 2 -- -- -- 2
Equity adjustment to conform fiscal periods. -- (78,644) (2,198) (14,738) 1,356 (94,224)
Unrealized gain on securities
available for sale, net................. -- -- -- -- 2,799 2,799
-----------------------------------------------------------------------------------
Balance, December 31, 1996.................. 17,191,479 133,241 117,039 (23,138) 5,639 232,781
Net income for 1997......................... -- -- 19,171 -- -- 19,171
Cash dividends ............................. -- (78,918) (8,619) -- -- (87,537)
Purchase and retirement of common stock .... (64,118) (1,126) (194) -- -- (1,320)
Purchase of shares by ESOP and restricted
stock trusts............................ -- -- -- (17,707) -- (17,707)
Shares released from ESOP and restricted
stock trusts............................ -- 332 -- 4,873 -- 5,205
Stock options exercised and Dividend
Reinvestment Plan stock issued.......... 69,560 1,263 17 -- -- 1,280
6-for-5 stock split......................... 1,260,172 5,809 (5,809) -- -- --
Pre-merger transactions of pooled bank...... 611,205 467 -- -- -- 467
Equity adjustment to conform fiscal
periods................................. -- 78,644 (1,706) 14,738 (1,356) 90,320
Unrealized gain on securities
available for sale, net................. -- -- -- -- 1,249 1,249
-----------------------------------------------------------------------------------
Balance, December 31, 1997.................. 19,068,298 $ 139,712 $ 119,899 $ (21,234) $ 5,532 $ 243,909
===================================================================================
See accompanying notes to consolidated financial statements.
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FIRST CHARTER CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................................... $ 19,171 $ 17,433 $ 15,878
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses........................................ 2,684 1,481 2,328
Depreciation and amortization.................................... 2,611 1,842 1,611
Premium amortization and (discount accretion), net............... 119 612 (124)
Net loss on investment securities held to maturity transactions -- -- 29
Net gain on securities available for sale transactions........... (5,694) (306) (19)
Amortization of unearned stock compensation...................... 5,205 3,764 425
Net loss (gain) on sale of other real estate..................... (104) (139) 197
Net loss (gain) on sale of premises and equipment................ (12) 4 (615)
Origination of mortgage loans held for sale...................... (11,843) (11,011) (22,960)
Proceeds from sale of mortgage loans held for sale............... 10,671 10,946 22,805
Increase in other assets......................................... (2,782) (2,097) (3,327)
Increase in other liabilities.................................... 2,665 1,233 3,187
---------------------------------------------
Net cash provided by operating activities.................... 22,691 23,762 19,415
---------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale................. 155,917 73,371 25,268
Proceeds from maturities and issuer calls of
investment securities held to maturity........................... 1,500 -- 36,623
Proceeds from maturities of securities available for sale............ 59,433 62,144 65,614
Purchase of investment securities.................................... (1,813) (4,948) (47,515)
Purchase of securities available for sale............................ (113,673) (49,863) (236,909)
Net increase in loans................................................ (205,633) (195,549) (134,283)
Proceeds from sales of other real estate............................. 1,655 119 2,655
Proceeds from sales of premises and equipment........................ 254 2,986 1,801
Purchase of premises and equipment................................... (5,863) (8,508) (2,230)
---------------------------------------------
Net cash used by investing activities............................ (108,223) (120,298) (288,976)
---------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand,
money market, and savings accounts............................... 41,466 31,219 18,252
Net increase in certificates of deposit.............................. 3,987 18,471 4,202
Net increase in securities sold under repurchase
agreements and other borrowings.................................. 120,183 185,181 88,716
Purchase and retirement of common stock.............................. (1,320) (486) (628)
Proceeds from issuance of common stock............................... 1,280 1,390 160,015
Pre-merger transactions of pooled bank............................... 467 2 2,632
Purchases of restricted stock for benefit plan....................... (17,707) (17,707) --
Dividends paid....................................................... (87,537) (86,846) (2,618)
---------------------------------------------
Net cash provided by financing activities........................ 60,819 131,224 270,571
---------------------------------------------
Net increase (decrease) in cash and cash equivalents............. (24,713) 34,738 1,010
Cash and cash equivalents at beginning of period................. 83,443 46,514 45,504
---------------------------------------------
Cash and cash equivalents at end of period....................... $ 58,730 $ 81,252 $ 46,514
=============================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest......................................................... $ 58,159 $ 57,101 $ 47,638
=============================================
Income taxes..................................................... $ 9,199 $ 7,458 $ 6,310
=============================================
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Transfers of loans and premises and equipment
to other real estate owned....................................... $ 3,445 $ 1,825 $ 2,139
=============================================
Investment securities transferred to available for sale.............. $ 13,979 $ -- $ 192,082
=============================================
Unrealized gain (loss) in value of securities available for sale, net $ 1,249 $ 2,799 $ (532)
=============================================
See accompanying notes to consolidated financial statements.
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FIRST CHARTER CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the more significant accounting and
reporting policies which First Charter Corporation (the "Corporation") and its
subsidiaries, First Charter National Bank ("First Charter"), Bank of Union
("Union"), and Home Federal Savings and Loan Association ("Home Federal")
(collectively referred to as the "Banks"), follow in preparing and presenting
their consolidated financial statements. In consolidation, all significant
intercompany accounts and transactions have been eliminated. All historical
financial data has been adjusted to reflect the mergers with HFNC Financial
Corp. ("HFNC") in 1998, Carolina State Bank ("CSB") in 1997 and Union in 1995,
each of which was accounted for as a pooling of interests (Note 2 and 21).
(a) Securities - The Corporation accounts for investment securities under
the provisions of the Financial Accounting Standards Board's (FASB) Statement
of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." At December 31, 1997 all of the
Corporation's securities are categorized as available-for-sale and,
accordingly, are reported at fair value, with any unrealized gains or losses,
net of taxes, shown as a separate component of shareholders' equity. The
Corporation intends to hold these available-for-sale securities for an
indefinite period of time but may sell them prior to maturity in response to
changes in interest rates, changes in prepayment risk, changes in the liquidity
needs of the Banks, and other factors.
Gains and losses on sales of securities are recognized when realized on a
specific identification basis. Premiums and discounts are amortized into
interest income using a level yield method.
(b) Loans - Loans are carried at their principal amount outstanding.
Interest income is recorded as earned on an accrual basis. The determination to
discontinue the accrual of interest is based on a review of each loan.
Generally, interest is discontinued on loans 90 days past due as to principal
or interest unless in management's opinion collection of both principal and
interest is assured by way of collateralization, guarantees or other security
and the loan is in the process of collection. Loans are returned to accrual
status when management determines, based on an evaluation of the underlying
collateral together with the borrower's payment record and financial condition,
that the borrower has the ability and intent to meet the contractual
obligations of the loan agreement.
Management considers a loan to be impaired when, based on current
information and events, it is probable that a creditor will be unable to
collect all amounts due according to contractual terms of the loan agreement.
Factors that influence management's judgment include, but are not limited to,
loan payment pattern, source of repayment, and value of collateral. A loan
would not be considered impaired if an insignificant delay in loan payment
occurs and management expects to collect all amounts due. The major sources for
identification of loans to be evaluated for impairment include past due and
nonaccrual reports, internally generated lists of loans of certain risk grades,
and regulatory reports of examination.
The Corporation uses the allowance method to provide for loan losses.
Accordingly, all loan losses are charged to the allowance for loan losses and
all recoveries are credited to it. The provision for loan losses is based on
past loan loss experience and other factors which, in management's judgment,
deserve current recognition in estimating possible loan losses. Such other
factors considered by management include the growth and composition of the loan
portfolio, the relationship of the allowance for loan losses to outstanding
loans, and economic conditions.
Allowances for loan losses related to loans that are identified as
impaired in accordance with the policy set forth above are based on discounted
cash flows using the loans' initial interest rates or the fair value of the
collateral if the loan is collateral dependent. Large groups of
smaller-balanced, homogenous loans that are collectively evaluated for
impairment (residential mortgage and consumer installment loans) are excluded
from this impairment evaluation and their allowance is calculated in accordance
with the allowance for loan losses policy discussed above.
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Management considers the December 31, 1997 allowance for loan losses
adequate to cover inherent losses in the Banks' loan portfolios. Management
believes it has established the allowance in accordance with generally accepted
accounting principles and in consideration of the current economic environment.
While management uses the best information available to make evaluations,
future additions to the allowance may be necessary based on changes in economic
and other conditions. Additionally, various regulatory agencies, as an integral
part of their examination process, periodically review the Banks' allowances
for loan losses. Such agencies may require the recognition of additions to the
allowance based on their judgments of information available to them at the time
of their examinations.
Mortgage loans held for sale are valued at the lower of cost or market as
determined by outstanding commitments from investors or current investor yield
requirements, calculated on the aggregate loan basis.
(c) Depreciation - Depreciation and amortization of premises and equipment
are computed using the straight-line method over the estimated useful lives.
The useful lives range from three to seven years for furniture and equipment,
from fifteen to forty years for buildings and over the terms of the respective
leases.
(d) Foreclosed Properties - Foreclosed properties are included in other
assets and represent real estate acquired through foreclosure or deed in lieu
thereof and are carried at the lower of cost (principal balance of the former
loan plus costs of obtaining title and possession) or fair value, less
estimated costs to sell. Generally the fair values of such properties are
evaluated annually and the carrying value, if greater than the estimated fair
value less costs to sell, is adjusted with a charge to income.
(e) Income Taxes - Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
the enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.
(f) Loan Fees and Costs - Nonrefundable loan fees and certain direct costs
associated with originating or acquiring loans are deferred and recognized over
the life of the related loans as an adjustment to interest income.
(g) Cash Flows - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks and federal funds
sold. Generally, federal funds are sold for one-day periods. Due to the
conforming of HFNC's year end to December 31, from June 30, as further
discussed at note 21, cash and cash equivalents at beginning of period do not
equal the amount of cash and cash equivalents per the balance sheet as of
December 31, 1996.
(h) Derivative Financial Instruments - All derivative financial
instruments held by the Corporation are held for purposes other than trading.
The Corporation currently uses interest rate floors on a limited basis for
interest rate risk management. Interest rate floors are designated as a hedge
of variable rate commercial loans. The net interest payable or receivable on
floors is accrued and recognized as an adjustment to interest income of the
related asset. Premiums paid for purchased floors are amortized over the
shorter of the term of the floor or the related asset. Upon the early
termination of floors, the net proceeds received or paid, including premiums,
are deferred and included in other assets or liabilities and amortized over the
shorter of the remaining contract life or the maturity of the related asset.
Upon disposition or settlement of the asset being hedged, deferral accounting
would be discontinued and changes in the fair value of the contract would be
recognized in earnings.
(i) Net Income Per Share - In February 1997, the FASB issued SFAS No. 128,
"Earnings Per Share," which applies to all entities with publicly held common
stock or potential common stock. This statement replaces the presentation of
primary earnings per share ("EPS") with a presentation of basic EPS. It also
requires dual presentation of basic and diluted EPS on the face of the income
statement for all entities with complex capital structures, and it requires a
reconciliation of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS computation. SFAS No. 128
requires restatement of all prior-period
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EPS data presented. The Corporation adopted this statement for the year ended
December 31, 1997. Therefore, the EPS data for the years ended December 31,
1996 and 1995 reflect compliance with this statement.
Basic net income per share is computed by dividing net income by the
weighted average number of shares of common stock outstanding for the year.
Diluted net income per share reflects the potential dilution that could occur
if the Corporation's common stock equivalents, which consist of dilutive stock
options, were exercised. The numerators of the basic net income per share
computations are the same as the numerators of the diluted net income per share
computations for all periods presented. A reconciliation of the denominator of
the basic net income EPS computations to the denominator of the diluted EPS
computations is as follows:
Years Ended December 31,
----------------------------------------------------------
1997 1996 1995
----------------------------------------------------------
Basic EPS denominator:
Weighted average number of common shares
outstanding................................. 18,154,131 18,301,085 8,779,066
Dilutive effect arising from assumed exercise
of stock options........................... 543,317 285,001 67,289
----------------------------------------------------------
Diluted EPS denominator....................... 18,697,448 18,586,086 8,846,355
==========================================================
Income per share amounts for the year ended December 31, 1995, include the
net income of $8,304,000 and weighted average shares outstanding of First
Charter Corporation, but exclude the net income and any weighted average shares
outstanding of HFNC, since HFNC was not a stock institution for the entire
period.
Income per share for periods prior to 1997 has been restated to reflect
the 6-for-5 stock split declared by the Corporation in the second quarter of
1997.
(j) Dividends Per Share - Dividends declared per share by First Charter
Corporation were $0.53 per share, $0.50 per share and $0.43 per share for the
years ended December 31, 1997, 1996 and 1995, respectively. Dividends declared
per share by HFNC were $5.28 per share and $0.12 per share for the years ended
December 31, 1997 and 1996, as adjusted to conform to First Charter
Corporation's December 31 fiscal year. HFNC declared no dividends during the
year ended December 31, 1995. Dividends declared per share by HFNC in the year
ended December 31, 1997 includes a special distribution of $5.00 per share to
HFNC shareholders, substantially all for which was deemed to be a return of
capital to shareholders.
(k) Stock-Based Compensation - SFAS No. 123, "Accounting for Stock-Based
Compensation", was issued by the FASB in October 1995. SFAS No. 123 requires
that the fair value of employee stock-based compensation plans be recorded as a
component of compensation expense in the statement of income as of the date of
grant of awards related to such plans or that the impact of such fair value on
net income and earnings per share be disclosed on a pro forma basis in a
footnote to the financial statements for awards granted after December 15,
1994, if the accounting for such awards continues to be in accordance with
Accounting Principles Board Opinion No. 25, (APB 25). The Corporation adopted
SFAS No. 123 on January 1, 1996 and has elected to continue accounting for
stock-based compensation under the provisions of APB 25. The pro forma impact
on net income and earnings per share is disclosed in Note 15.
(2) MERGERS
Carolina State Bank. On August 15, 1997, the Corporation entered into an
Agreement and Plan of Merger with CSB, pursuant to which CSB merged with and
into First Charter (the "CSB Merger"). On December 22, 1997, the CSB Merger was
completed and was accounted for as a pooling of interests. Accordingly, all
current and prior years' consolidated financial statements have been restated
to combine the accounts of CSB with those of the Corporation.
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As of December 22, 1997, there were 1,663,992 shares of CSB common stock
outstanding. Each share of CSB common stock was converted into 1.023 shares of
the Corporation's common stock.
CSB was a North Carolina-chartered commercial bank providing general
banking services through a network of four branch offices located in Shelby,
Kings Mountain, Boiling Springs and Forest City, North Carolina, which are now
branches of First Charter. At December 31, 1996, CSB had total assets of
approximately $133 million and total deposits of approximately $115 million. In
the fourth quarter of 1997, the Corporation recognized $3,355,680 of costs
associated with the acquisition of CSB. The primary components of these
merger-related expenses were transaction and professional expenses and various
severance-related obligations.
Separate results of operations of the combined entities for the nine
months ended September 30, 1997, and years ended December 31, 1996 and 1995
were as follows (dollars in thousands, except per share data):
Nine Months Ended September 30, Years Ended December 31,
------------------------------- ---------------------------------------------------------
1997 1996 1995
------------------------------- ---------------------------- ----------------------------
Pre-merger Pre-merger Pre-merger
---------- ---------- ----------
Corp- Corp- Corp-
oration CSB Restated oration CSB Restated oration CSB Restated
-----------------------------------------------------------------------------------------
Net interest income..... $18,891 $4,069 $22,960 $23,313 $4,797 $28,110 $21,984 $4,115 $26,099
Net income ............. 7,401 717 8,118 8,853 1,216 10,069 7,003 1,301 8,304
Basic income
per share ............. 0.97 0.44 0.88 1.17 0.76 1.10 0.94 1.02 0.95
Diluted income
per share ............. 0.97 0.44 0.87 1.17 0.76 1.09 0.93 1.02 0.94
Union. On December 21, 1995, the Corporation completed its acquisition of
Union, in which a newly formed subsidiary of the Corporation merged with Union
and Union became a wholly owned subsidiary of the Corporation. The acquisition
of Union was accounted for as a pooling of interests.
Union is a state-chartered commercial bank organized under the laws of
North Carolina in 1985. At December 31, 1995, Union had total assets of
approximately $147 million and total deposits of approximately $129 million.
Union provides general banking services through a network of five branch
offices located in Union and Mecklenburg Counties, North Carolina. Through its
subsidiary, BOU Financial, Inc., Union also offers discount brokerage services,
insurance and annuity sales and financial planning services. In the fourth
quarter of 1995, the Corporation recognized $1,062,150 of costs associated with
the acquisition of Union. These costs primarily included legal, accounting,
investment banking, regulatory filings, proxy printing and solicitation
expenses.
Refer to note 21 for a discussion of mergers completed subsequent to
December 31, 1997.
(3) FINANCIAL STATEMENT PRESENTATIONS AND RELATED MATTERS
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts of assets and
liabilities and disclosure of contingent liabilities at the date of the
financial statements, as well as the amounts of income and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications of certain amounts in the previously issued consolidated
financial statements have been made to conform with the financial statement
presentation for 1997. Such reclassifications had no effect on the net income
or shareholders' equity of the combined entity as previously reported.
As discussed in note 21, the Corporation completed a pooling-of-interests
merger with HFNC on September 30, 1998. The accompanying consolidated financial
statements have been restated to include the effects of this merger
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for all periods presented. HFNC's fiscal period was conformed from a June 30
year end to the December 31 year end of the Corporation for the preparation of
the 1997 consolidated financial statements. See note 21 for additional
discussion.
(4) SECURITIES AVAILABLE FOR SALE
Securities available for sale at December 31, 1997 and 1996 are summarized
as follows:
GROSS GROSS
(Dollars in thousands) AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------------------------------
1997
U.S. Government obligations...................... $ 22,072 $ 267 $ 6 $ 22,333
U.S. Government agency obligations............... 120,805 188 255 120,739
Mortgage-backed securities....................... 58,787 812 50 59,548
State, county and municipal obligations.......... 83,796 1,897 161 85,532
Equity securities................................ 21,068 6,345 -- 27,413
---------------------------------------------------------------
Total ...................................... $ 306,528 $ 9,509 $ 472 $ 315,565
===============================================================
1996
U.S. Government obligations...................... $ 38,732 $ 408 $ 45 $ 39,095
U.S. Government agency obligations............... 127,563 127 1,846 125,844
Mortgage-backed securities....................... 67,576 557 422 67,711
State, county and municipal obligations.......... 71,172 1,480 602 72,050
Equity securities................................ 11,592 9,544 11 21,125
---------------------------------------------------------------
Total ...................................... $ 316,635 $ 12,116 $ 2,926 $ 325,825
===============================================================
A schedule of debt securities by contractual maturity at December 31, 1997
is shown below on an amortized cost basis and on a fair value basis. Actual
maturities could differ from contractual maturities due to call or prepayment
provisions.
Amortized Fair
(Dollars in thousands) Cost Value
----------- -----------
Due in one year or less....................... $ 15,282 $ 15,311
Due from one to five years.................... 88,174 89,280
Due from five to ten years.................... 78,275 78,874
Due after 10 years............................ 44,942 45,139
Mortgage-backed securities.................... 58,787 59,548
----------- -----------
Total....................................... $ 285,460 $ 288,152
=========== ===========
Securities with an aggregate carrying value of $159,492,000 at December
31, 1997 were pledged to secure public deposits, securities sold under
agreements to repurchase and Federal Home Loan Bank ("FHLB") borrowings.
Proceeds from the sale of securities available for sale were $155,917,000 in
1997, $73,371,000 in 1996, and $25,268,000 in 1995. Gross gains of $6,825,000
and gross losses of $1,131,000 were realized in 1997. Gross gains of $1,024,000
and gross losses of $718,000 were realized in 1996. Gross gains of $102,000 and
gross losses of $83,000 were realized in 1995. At December 31, 1997 and 1996,
the Banks owned stock in the Federal Home Loan Bank of Atlanta with book and
fair values of $15,214,000 and $7,969,000, respectively, which is included in
equity securities.
12
(5) INVESTMENT SECURITIES HELD TO MATURITY
During December 1995, the entire portfolio of First Charter Corporation's
investment securities held to maturity, with an amortized cost of $190,323,076
and unrealized gains of $1,758,258, was transferred to securities available for
sale, in accordance with FASB's implementation guide for SFAS 115, "Accounting
for Certain Investments in Debt and Equity Securities". In addition, following
the merger with CSB in 1997, First Charter transferred CSB's investment
securities with an amortized cost of $13,464,188 and unrealized gains of $27,073
to securities available for sale.
The amortized cost and estimated fair values of investment securities held
to maturity at December 31, 1996, are presented below:
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------------
U.S. Government obligations......... $13,940 $39 -- $13,979
=============================================================
(6) LOANS
The Corporation's primary market area includes the states of North and
South Carolina, and predominately centers on the Metro region of Charlotte,
North Carolina. At December 31, 1997, the majority of the total loan portfolio,
as well as a substantial portion of the commercial and real estate loan
portfolios, were to borrowers within this region. The diversity of the region's
economic base tends to provide a stable lending environment. An area of
significant concentration of credit risk has not been specified due to the
diverse industrial base in the region.
Loans at December 31, 1997 and 1996 are as follows:
(Dollars in thousands) 1997 1996
- -----------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural................................... $ 80,675 $ 63,686
Real estate - construction............................................... 133,303 102,460
Real estate - commercial................................................. 163,615 158,903
Real estate - residential................................................ 800,922 710,352
Installment.............................................................. 88,546 92,567
-----------------------------
Total............................................................... $ 1,267,061 $ 1,127,968
=============================
Nonaccrual loans included above.......................................... $ 6,119 $ 7,949
Other real estate........................................................ 4,006 1,627
Loans 90 days or more past due and still
accruing included above............................................. 2,109 685
Restructured loans....................................................... 587 643
-----------------------------
Total problem assets................................................ $ 12,821 $ 10,904
=============================
13
Residential real estate loans are presented net of loans serviced for
others totaling $28.0 million and $30.9 million at December 31, 1997 and 1996,
respectively. Loans sold into the secondary market are generally sold without
recourse, and the terms of such sales generally include the release of the right
to service the loans. The Corporation does not have any recorded mortgage
servicing rights at December 31, 1997 or 1996.
Interest income that would have been recorded on nonaccrual loans and
restructured loans for the years ended December 31, 1997, 1996, and 1995, had
they performed in accordance with their original terms, amounted to
approximately $339,000, $646,000, and $1,120,000, respectively. Interest
income on all such loans included in the results of operations for 1997, 1996,
and 1995 amounted to approximately $383,000, $154,000, and $267,000,
respectively.
The recorded investment in impaired loans was $4,725,248 (of which
$4,448,641 was on nonaccrual) and $6,340,204 (of which $5,752,309 was on
nonaccrual) for 1997 and 1996, respectively. The related allowance for loan
losses on these loans was $1,281,139 and $2,703,895 for 1997 and 1996,
respectively. The average recorded investment in impaired loans for 1997 was
$4,795,144, and the income recognized during 1997 was $66,616, $36,496 of which
was recognized using the cash method of income recognition. The average recorded
investment in impaired loans for 1996 was $7,370,027, and the income recognized
during 1996 was $249,905, $143,562 of which was recognized using the cash method
of income recognition. The average recorded investment in impared loans for 1995
was $10,124,408, and the income recognized during 1995 was $222,746, $183,294 of
which was recognized using the cash method of income recognition.
The following is a reconciliation of loans outstanding to executive
officers, directors and their associates for the year ended December 31, 1997:
(Dollars in thousands)
Balance at December 31, 1996................................................................. $ 11,871
New loans.................................................................................... 3,106
Principal repayments......................................................................... (7,099)
---------
Balance at December 31, 1997................................................................. $ 7,878
=========
In the opinion of management, these loans were made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other borrowers. Such loans, in the
opinion of management, do not involve more than the normal risks of
collectibility.
(7) ALLOWANCE FOR LOAN LOSSES
The following is a summary of the changes in the allowance for loan losses
for each of the years in the three-year period ended December 31, 1997:
(Dollars in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Beginning balance............................................. $ 14,140 $ 13,552 $ 13,144
Provision charged to operations............................... 2,684 1,481 2,328
Adjustment for merged bank.................................... 269 -- --
Charge-offs................................................... 2,261 1,810 2,699
Recoveries.................................................... 431 917 779
---------------------------------------------
Net charge-offs.......................................... 1,830 893 1,920
---------------------------------------------
Ending balance................................................ $ 15,263 $ 14,140 $ 13,552
=============================================
14
(8) PREMISES AND EQUIPMENT
Premises and equipment at December 31, 1997 and 1996 are summarized as
follows:
(Dollars in thousands) 1997 1996
- ----------------------------------------------------------------------------------------------------------
Land............................................................................ $ 7,957 $ 6,981
Buildings....................................................................... 18,871 18,262
Furniture and equipment......................................................... 15,262 13,248
Leasehold improvements.......................................................... 1,005 799
------------------------
43,095 39,290
Less accumulated depreciation and amortization.................................. 17,038 15,237
------------------------
Premises and equipment, net..................................................... $ 26,057 $ 24,053
========================
(9) DEPOSITS
A summary of deposit balances at December 31, 1997 and 1996 is as follows:
(Dollars in thousands) 1997 1996
- ------------------------------------------------------------------------------------------------------------
Noninterest bearing demand...................................................... $ 103,005 $ 103,353
Interest bearing demand......................................................... 111,566 101,492
Insured money market accounts................................................... 113,326 80,936
Savings deposits................................................................ 131,276 136,090
Certificates of deposit......................................................... 600,089 591,825
--------------------------
Total........................................................................... $ 1,059,262 $ 1,013,696
==========================
The aggregate amount of certificates of deposit with denominations greater
than $100,000 was $146,496,000, and $138,284,000 at December 31, 1997, and 1996.
At December 31, 1997, the scheduled maturities of all certificates of
deposit are as follows:
(Dollars in thousands)
1998...................................... $ 418,706
1999...................................... 135,416
2000...................................... 37,860
2001...................................... 4,084
2002 and after............................ 4,203
------------
$ 600,089
============
15
(10) OTHER BORROWINGS
The following is a schedule of other borrowings:
INTEREST MAXIMUM
BALANCE RATE AVERAGE OUTSTANDING
AS OF AS OF AVERAGE INTEREST AT ANY
(Dollars in thousands) DECEMBER 31, DECEMBER 31, BALANCE RATE MONTH-END
- ------------------------------------------------------------------------------------------------------------------------------
1997
Federal funds purchased and securities
sold under agreements
to repurchase ................. $ 113,146 5.20% $ 136,193 5.67% $ 148,855
FHLB borrowings..................... 236,933 5.77% 136,473 5.85% 236,934
Other............................... -- -- 10,500 9.00% 28,000
---------- ----------- ----------
Total.......................... $ 350,079 $ 283,166 $ 413,789
========== =========== ==========
1996
Federal funds purchased and securities
sold under agreements
to repurchase ................. $ 141,728 5.65% $ 139,570 5.60% $ 142,868
FHLB borrowings..................... 140,167 5.92% 71,478 5.97% 88,168
Other............................... 28,000 9.00% 7,900 9.00% 28,000
---------- ----------- ----------
Total.......................... $ 309,895 $ 218,948 $ 259,036
========== =========== ==========
Federal funds purchased represent unsecured overnight borrowings from other
financial institutions by the Banks. Securities sold under agreement to
repurchase represent short-term borrowings by the Banks with maturities ranging
from 1 to 89 days collateralized by a portion of the Corporation's securities of
the United States government or its agencies, which have been delivered to a
third party custodian for safekeeping.
At December 31, 1997, the Banks had three available lines of credit with
the FHLB totaling $302,500,000 with $236,933,000 outstanding. The outstanding
amounts consist of $132,400,000 maturing in 1998, $260,417 maturing in 1999,
$1,142,858 maturing in 2001, $102,000,000 maturing in 2002, $600,000 maturing in
2003, and $530,000 maturing in 2011. In addition, the Banks are required to
pledge collateral to secure the advances as described in the line of credit
agreements. The collateral consists of FHLB stock and qualifying 1-4 family
residential mortgage loans.
16
(11) DERIVATIVE FINANCIAL INSTRUMENTS
Off-balance sheet derivative financial instruments, such as interest rate
swaps, interest rate floor and cap arrangements and interest rate futures and
option contracts, are available to the Corporation to assist in managing
interest rate risks. As of December 31, 1997 and 1996, the Corporation has only
used interest rate floors. Interest rate floors are used to protect certain
designated variable rate financial instruments from the downward effects of
their repricing in the event of a decreasing rate environment. The Corporation
is using this financial instrument as a hedge of certain designated variable
rate loans. The total cost of this arrangement was $130,000, which is being
amortized on a straight-line basis for the life of the commercial instrument.
The Corporation expensed $26,000 related to this financial instrument for each
of the years ended December 31, 1997, 1996 and 1995. During part of 1997, the
index rate was below the floor rate, and the Corporation recognized $12,000 as
additional interest income on its variable rate loans. The fair value of this
financial instrument was $91,000 compared to a book value of $52,000 at December
31, 1997 and a fair value of $276,000 compared to a book value of $78,000 at
December 31, 1996. The table below summarizes the Corporation's off-balance
sheet derivative financial instrument at December 31, 1997.
Interest rate floor agreements at December 31, 1997:
Current
Notional Floor Index Maturity
(Dollars in thousands) Amount Rate Rate Date
- -------------------------------------------------------------------------------------------------------------------
Interest rate floors........................... $ 20,000 8.50% 8.50% 1/23/2000
=============================================================
Interest rate floor agreements at December 31, 1996:
Current
Notional Floor Index Maturity
(Dollars in thousands) Amount Rate Rate Date
- -------------------------------------------------------------------------------------------------------------------
Interest rate floors........................... $ 20,000 8.50% 8.25% 1/23/2000
=============================================================
17
(12) OTHER NONINTEREST EXPENSE
Components of other noninterest expense in excess of one percent of the
aggregate amount of total interest income and total noninterest income are as
follows:
(Dollars in thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
Advertising............................................. $ 1,996 $ 1,515 $ 1,451
Data processing......................................... 1,192 886 666
Professional services................................... 3,515 3,330 1,935
FDIC insurance.......................................... 353 686 1,644
Special one-time SAIF assessment........................ -- 3,077 --
Stationery and supplies................................. 1,009 1,062 887
Merger related.......................................... 3,356 -- 1,062
All other items......................................... 4,187 4,095 5,158
-------------------------------------------
Total.............................................. $ 15,608 $ 14,651 $ 12,803
===========================================
(13) INCOME TAX
Income tax expense (benefit) consists of the following:
(Dollars in thousands) Current Deferred Total
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1997
FEDERAL................................................. $ 10,949 $ (1,635) $ 9,314
STATE................................................... 1,789 (338) 1,451
-------------------------------------------
TOTAL.............................................. $ 12,738 $ (1,973) $ 10,765
===========================================
Year ended December 31, 1996
Federal................................................. $ 8,425 $ (155) $ 8,270
State................................................... 780 (22) 758
-------------------------------------------
Total.............................................. $ 9,205 $ (177) $ 9,028
==========================================
Year ended December 31, 1995
Federal................................................. $ 7,339 $ (577) $ 6,762
State................................................... 788 (83) 705
-------------------------------------------
Total.............................................. $ 8,127 $ (660) $ 7,467
===========================================
Income tax expense differed from the amounts computed by applying the U.S.
federal income tax rate of 35% to pretax income as a result of the following:
1997 1996 1995
--------------------------------------------------------------------------
% OF % of % of
PRETAX Pretax Pretax
(Dollars in thousands) AMOUNT INCOME Amount Income Amount Income
- -------------------------------------------------------------------------------------------------------------------------
Income before income taxes.............. $ 29,936 $ 26,461 $ 24,395
========= ========== ==========
Tax at federal income tax rate.......... 10,477 35.0% 9,261 35.0% 8,538 35.0%
Reasons for differences:
Tax exempt income.................. (1,199) (4.0) (1,088) (4.1) (805) (3.3)
Nondeductible merger expense....... 459 1.5 -- -- 330 1.4
State income tax, net of
federal benefit................ 943 3.2 498 1.9 470 1.9
Change in deferred tax assets
valuation allowance............ -- -- -- -- (637) (2.6)
Statutory bad debt deduction for
tax purposes................... -- -- -- -- (535) (2.2)
Other.............................. 85 0.3 357 1.3 106 0.4
-------------------------------------------------------------------------
Total.......................... $ 10,765 36.0% $ 9,028 34.1% $ 7,467 30.6%
=========================================================================
18
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1997 and 1996 are presented below.
(Dollars in thousands) 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
Deferred Tax Assets:
Allowance for loan losses.................................................. $ 5,620 $ 5,185
Deferred loan fees......................................................... 590 794
Accrued expenses deductible when paid for tax purposes..................... 1,062 254
Deferred compensation...................................................... 1,541 2,011
Net operating loss carryforward............................................ 568 678
Management recognition and retention plan compensation accrual............. 966 296
Other...................................................................... 394 105
-----------------------------
Total gross deferred tax assets........................................ 10,741 9,323
Less valuation allowance................................................... -- --
-----------------------------
Deferred tax asset, net of valuation allowance......................... 10,741 9,323
-----------------------------
Deferred Tax Liabilities:
Unrealized gains on securities available for sale, net..................... (3,505) (3,551)
Fixed assets, primarily due to difference in depreciation.................. (127) (122)
Federal Home Loan Bank of Atlanta stock.................................... (876) (922)
Other...................................................................... (78) (592)
-----------------------------
Total gross deferred tax liability..................................... (4,586) (5,187)
-----------------------------
Net deferred tax asset................................................. $ 6,155 $ 4,136
=============================
A portion of the current year change in the net deferred tax asset relates
to unrealized gains and losses on securities available for sale. The related
current period deferred tax benefit of $46,000 has been recorded directly to
shareholders' equity. The balance of the change in the net deferred tax asset
results from the current period deferred tax benefit of $1,973,000.
There was no valuation allowance for deferred tax assets as of December 31,
1997 and 1996. There was no change in the total valuation allowance during 1997
and 1996. It is management's belief that realization of the deferred tax asset
is more likely than not.
Tax returns for 1994 and subsequent years are subject to examination by
taxing authorities.
Retained income at December 31, 1997 and 1996 includes approximately $6.76
million (tax effect) representing pre-1988 tax bad debt reserve base year
reserve amounts for which no deferred income tax liability has been provided
since these reserves are not expected to reverse and may never reverse.
Circumstances that would require an accrual of a portion or all of this
unrecorded tax liability are a reduction in qualifying loan levels relative to
the end of 1987, failure to meet the definition of a bank, dividend payments in
excess of current year or accumulated tax earnings and profits, or other
distributions in dissolution, liquidation or redemption of Bank's stock.
(14) EMPLOYEE BENEFIT PLANS
401(k) Plan. The Corporation has a qualified Retirement Savings Plan
(401(k) Plan) for all eligible employees of First Charter and Union. Subsequent
to the merger of the Corporation with HFNC, employees of HFNC are also eligible
to participate in the 401(k) Plan. Pursuant to the Savings Plan, an eligible
employee may elect to defer between 1% and 10% of compensation. In the
discretion of the Board of Directors, the Corporation may contribute an amount
necessary to match all or a portion of a participant's elective deferrals in an
amount to be determined by the Board of Directors from time to time, up to a
maximum of 6% of a participants compensation. In addition, the Corporation may
contribute an additional amount to each participant's Savings Plan account as
determined in the discretion of the Board of Directors. The Corporation adopted
a qualified Money Purchase Pension Plan effective January 1, 1997 for all
eligible employees of First Charter and Union. Pursuant to the Money
19
Purchase Plan, the Corporation contributes annually to each participant's Plan
account an amount equal to 3% of the participant's compensation. Prior to 1997,
such contributions were made to the Savings Plan. The Corporation's (excluding
Home Federal) aggregate contribution to the Savings Plan and Money Purchase
Pension Plan was $626,941, $559,566 and $408,421 for 1997, 1996 and 1995,
respectively.
Profit Sharing Plan. Home Federal sponsors a contributory 401(k) profit
sharing plan ("Profit Sharing Plan"). The Profit Sharing Plan permits all full
time employees with at least one year of service to contribute up to 9% of their
salary to the plan each year. The plan provides for matching contributions by
Home Federal equal to 100% of employee contributions up to the first 3% of
compensation. Home Federal may, at its discretion, make profit sharing
contributions to the plan. Plan participants' accounts are 100% vested in
Company contributions after 5 years of qualifying service. Home Federal's
matching contributions charged to expense for 1997, 1996, and 1995 was
approximately $52,000, $76,000 and $69,000, respectively. The Profit Sharing
Plan is anticipated to be merged into First Charter's 401(k) profit sharing plan
during first quarter 1999.
20
(15) COMMON STOCK
On May 21, 1997, the Board of Directors of the Corporation declared a
6-for-5 stock split payable on July 15, 1997 to shareholders of record on June
20, 1997. All per share data in the consolidated financial statements has been
retroactively adjusted for the stock split.
On December 15, 1997, the shareholders of the Corporation approved Amended
and Restated Articles of Incorporation for the Corporation which included
amendments to, among other things, (i) increase the number of shares of common
stock that the Corporation is authorized to issue from 10,000,000 to 25,000,000
and (ii) eliminate the concept of par value in connection with the Corporation's
common stock. These changes have been reflected in the accompanying consolidated
financial statements.
The Corporation maintains the Dividend Reinvestment and Stock Purchase Plan
(the "DRIP"), pursuant to which 240,000 shares (as adjusted to reflect the stock
splits) of common stock of the Corporation have been reserved for issuance.
Shareholders may elect to participate in the DRIP and have dividends on shares
of common stock reinvested and may make optional cash payments of up to $2,500
per calendar quarter to be invested in common stock of the Corporation. Pursuant
to the terms of the DRIP, upon reinvestment of the dividends and optional cash
payments, either the Corporation can issue new shares valued at the then current
market value of the common stock or the administrator of the DRIP can purchase
shares of common stock in the open market. During 1997, the Corporation issued
56,995 shares and the administrator of the DRIP purchased 2,250 shares on the
open market.
Under the terms of the First Charter Corporation Comprehensive Stock Option
Plan (the "Comprehensive Plan"), stock options (which can be incentive stock
options or non-qualified stock options) may be periodically granted to key
employees of the Corporation or its subsidiaries. The terms and vesting
schedules of options granted under the Comprehensive Plan generally shall be
determined by the Compensation Committee of the Board of Directors of the
Corporation (the "Compensation Committee"). No options, however, may be
exercisable prior to six months following the grant date, and certain additional
restrictions, including the term and exercise price, apply with respect to any
incentive stock options. In May 1996, the shareholders of the Corporation
approved an increase in the number of shares reserved for issuance under the
Comprehensive Plan from 288,000 shares (as adjusted for the stock split) to
480,000 shares (as adjusted for the stock split). Accordingly, on January 1,
1996, the summary stock option activity table, included in this Note, has been
adjusted to reflect an increase of 192,000 shares available for grant.
In April 1995, the shareholders approved the First Charter Corporation
Restricted Stock Award Program (the "Restricted Stock Plan"). Awards of
restricted stock may be made under the Restricted Stock Plan at the discretion
of the Compensation Committee of the Board of Directors of the Corporation,
which shall determine the key participants, the number of shares awarded to
participants, and the vesting terms and conditions applicable to such awards. A
maximum of 360,000 shares of common stock (as adjusted to reflect the stock
split) are reserved for issuance under the Restricted Stock Plan. There had been
no shares granted under this plan at December 31, 1997.
In April 1997, the shareholders approved the First Charter Corporation
Stock Option Plan for Non-Employee Directors (the "Director Plan"). Under the
Director Plan, non-statutory stock options may be granted to non-employee
Directors of the Corporation and its subsidiaries. The terms and vesting
schedules of any options granted under the Director Plan generally shall be
determined by the Compensation Committee of the Board of Directors of the
Corporation. The exercise price for each option granted, however, shall be the
fair value of the common stock as of the date of grant. A maximum of 180,000
shares (as adjusted to reflect the stock split) are reserved for issuance under
the Director Plan. No grants had been made pursuant to this plan at December 31,
1997.
21
Periodically, the Corporation adopts an Employee Stock Purchase Plan (the
"ESPP"), pursuant to which stock options are granted to employees, based on
their eligibility and compensation, at a price not less than 90% of the fair
market value of the shares at the date of grant. The option and vesting period
is generally for a term of two years. A maximum of 180,000 shares (as adjusted
to reflect the stock split) are reserved for issuance under the 1996 ESPP and
180,000 shares (as adjusted to reflect stock split) are reserved for issuance
under the 1998 ESPP, which was approved by the shareholders of the Corporation
in April 1997.
The Management Recognition and Retention Plan ("MRRP") is sponsored by
Home Federal and provides for Home Federal's Board of Directors to award
restricted stock to officers and key employees of Home Federal as well as
non-employee directors of Home Federal. The MRRP authorizes Home Federal to
grant up to 687,000 shares of Corporation stock. One-fifth of the shares granted
vested immediately upon grant, with the remainder vesting at a rate of 25% per
year over the next four anniversary dates of the grants. Shares granted will be
vested in the event of retirement, disability, or death. Approximately
$3,200,000 in compensation expense was recognized in each of the years ended
December 31, 1997 and 1996, related to the MRRP. There was no MRRP expense for
the year ended December 31, 1995. Subsequent to the consummation of the merger
of the Corporation with HFNC, no further grants of MRRP shares will be made. The
following table presents the status of the MRRP as of December 31, 1997 and 1996
and changes during the years then ended:
Weighted Average
Management Recognition and Retention Plan Shares Grant Price
Outstanding at December 31, 1995.................................. -- $ --
Granted...................................................... 53,138 30.54
Vested....................................................... (70,628) 31.70
Forfeited.................................................... (342) 30.26
-------
Outstanding at December 31, 1996.................................. 282,168
Granted...................................................... -- --
Vested....................................................... (35,313) 30.26
Forfeited.................................................... (228) 30.26
-------
Outstanding at December 31, 1997 246,627
=======
In connection with its conversion to a stock savings and loan
association, Home Federal established an Employee Stock Ownership Plan ("ESOP").
Concurrent with the conversion, 900,000 shares of the Corporation's common stock
were purchased on December 28, 1995 by the ESOP with the proceeds of a $9.0
million loan from Home Federal's wholly owned subsidiary, HFNC Investment Corp.
A corresponding amount related to unearned ESOP shares of $11,343,587 and
$11,956,555 at December 31, 1997 and 1996, respectively, is shown as a reduction
of shareholder's equity. As the loan is internally leveraged, the note
receivable from the ESOP is not reported as an asset nor is the ESOP's debt
reported as a liability. Compensation expense related to the ESOP was
approximately $1,670,000 and $1,500,000 million for each of the years ended
December 31, 1997 and 1996.
At December 31, 1997, as described above, the Corporation has various
stock-based compensation plans. The Corporation adopted SFAS 123, "Accounting
for Stock-Based Compensation" on January 1, 1996, and elected to continue to
measure compensation cost relative to these plans using APB 25. The disclosure
of the pro forma net income and earnings per share as if the fair value based
accounting method of SFAS 123 had been used to account for stock-based
compensation is required only for awards granted after December 31, 1994, and is
provided below. Consequently, the effects of applying SFAS 123 pro forma
disclosures during the initial phase-in period may not be representative of the
effects on reported net income in future years.
22
The following table presents the pro forma effect on net income and basic
diluted income per share of applying the fair value provisions of SFAS No. 123
discussed above:
Years Ended December 31,
---------------------------------------------
(Dollars in thousands, except per share data) 1997 1996 1995
---------------------------------------------------------------------------------------------------
Net income:
As reported............................. $ 19,171 $ 17,433 $ 15,878
Pro forma............................... $ 18,879 $ 16,408 $ 15,682
Basic income per share:
As reported............................. $ 1.06 $ 0.95 $ 0.95
Pro forma............................... $ 1.04 $ 0.90 $ 0.94
Diluted income per share:
As reported............................. $ 1.03 $ 0.94 $ 0.94
Pro forma............................... $ 1.01 $ 0.88 $ 0.93
The fair value of each option granted during 1997, 1996 and 1995 was
estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Years Ended December 31,
-------------------------------------------------------
1997 1996 1995
-------------------------------------------------------
1997 Employee Stock Option Plan
Dividend yield.............................. N/A 1.7% N/A
Risk free interest rates.................... N/A 6.28% N/A
Expected lives.............................. N/A 4 years N/A
Volatility.................................. N/A 18% N/A
1996 Employee Stock Purchase Plan
Dividend yield.............................. N/A 2.9% N/A
Risk free interest rates.................... N/A 5.11% N/A
Expected lives.............................. N/A 2 years N/A
Volatility.................................. N/A 25% N/A
Comprehensive Stock Option Plan
Dividend Yield.............................. 3.0% 2.9% 2.9%
Risk free interest rates.................... 5.88% to 6.89% 6.14% 5.45% to 7.10%
Expected lives.............................. 6 years 6 years 6 years
Volatility.................................. 23% 21% 32%
Director Plan
Dividend Yield.............................. 3.0% N/A N/A
Risk free interest rates.................... 6.57% to 6.67% N/A N/A
Expected lives.............................. 6 years N/A N/A
Volatility.................................. 23% N/A N/A
23
The following is a summary of activity under the Comprehensive Plan,
Director Plan and the 1996 and 1993 ESPP's during the periods indicated. All
options outstanding have been adjusted to reflect the 1997 stock split. For
comparison purposes, HFNC and FCC were consolidated using conforming calendar
years.
Option Option Price Weighted Average
Shares Per Share Exercise Price
-------------------------------------------------------
Outstanding at December 31, 1994 160,952 $ 3.64 - 12.26 $ 8.18
Granted............................ 68,184 12.29 - 17.92 17.38
Exercised.......................... 46,768 3.64 - 12.26 7.38
Forfeited.......................... 9,537 3.64 - 12.26 8.47
---------
Outstanding at December 31, 1995 172,831 3.64 - 17.92 12.01
Granted............................ 959,874 16.50 - 25.93 23.85
Exercised.......................... 14,307 3.64 - 12.40 6.37
Forfeited.......................... 8,920 5.34 - 17.92 8.35
---------
Outstanding at December 31, 1996 1,109,478 3.64 - 25.93 22.31
Granted............................ 87,600 17.60 - 25.00 21.15
Exercised.......................... 35,662 3.64 - 18.85 13.40
Forfeited.......................... 8,227 8.75 - 17.92 17.60
---------
Outstanding at December 31, 1997 1,153,189 3.64 - 25.93 22.54
=========
Shares exercisable at December 31, 1997 726,862 $ 3.64 - 25.93 $ 22.30
=========
At December 31, 1997, there were 564 shares outstanding and exercisable
under the former Bank of Union Stock Option Plan with an average exercise price
of $6.35 and 58,104 shares outstanding and exercisable under the former Carolina
State Bank Option Plan with an average exercise price of $7.50, both of which
are not included in the table above.
The weighted average remaining contractual lives of stock options were
7.24, 7.47, and 8.60 years at December 31, 1997, 1996, and 1995, respectively.
24
(16) COMMITMENTS, CONTINGENCIES AND OFF-BALANCE-SHEET RISK
Commitments and Off-Balance-Sheet Risk. The Corporation is party to various
financial instruments with off-balance-sheet risk in the normal course of
business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit,
and involve, to varying degrees, elements of credit and interest rate risk in
excess of the amounts recognized in the consolidated financial statements. The
Corporation uses the same credit policies in making commitments and conditional
obligations as it does for instruments reflected in the consolidated financial
statements. The creditworthiness of each customer is evaluated on a case-by-case
basis.
At December 31, 1997, the Corporation's exposure to credit risk was
represented by preapproved but unused lines of credit for loans totaling
$175,209,000 and standby letters of credit aggregating $3,192,000. The amount of
collateral obtained if deemed necessary by the Corporation upon extension of
credit is based on management's credit evaluation of the borrower at that time.
The Corporation generally extends credit on a secured basis. Collateral obtained
may include, but may not be limited to, accounts receivable, inventory and
commercial and residential real estate. Management expects that these
commitments can be funded through normal operations.
The Banks grant primarily commercial and installment loans to customers
throughout their market areas. The Corporation's primary market area includes
the states of North and South Carolina, and predominately centers on the Metro
region of Charlotte, North Carolina. The real estate loan portfolio can be
affected by the condition of the local real estate markets.
Average daily Federal Reserve balance requirements for the year ended
December 31, 1997 amounted to $3,172,583.
Contingencies. In June 1995, a lawsuit was initiated against Home Federal
by a borrower's affiliated companies in which the plaintiffs alleged that Home
Federal wrongfully set-off certain funds in an account being held and maintained
by Home Federal. In addition, the plaintiffs alleged that as a result of the
wrongful set-off, Home Federal wrongfully dishonored a check in the amount of
$270,000. Plaintiffs further alleged that the actions on behalf of Home Federal
constituted unfair and deceptive trade practices, thereby entitling plaintiffs
to recover treble damages and attorneys' fees. Home Federal denied any
wrongdoing and filed a motion for summary judgment. Upon consideration of the
motion, the United States Bankruptcy Judge entered a Recommended Order Granting
Summary Judgement, recommending the dismissal of all claims asserted against
Home Federal. In October 1997, the United States District Court entered an order
granting summary judgment in favor of Home Federal. The plaintiff has appealed
the order of summary judgment and the case is presently pending in the Fourth
Circuit Court of Appeals.
In December 1996, Home Federal filed a suit against the borrower and his
company and against the borrower's wife, daughters, and a company owned by his
wife and daughter, alleging transfers of assets to the wife, daughter, and their
company in fraud of creditors, and asking that the fraudulent transfers be set
aside. The objective of the lawsuit is to recover assets which may be used to
satisfy a portion of the judgments obtained in favor of Home Federal prior to
litigation. The borrower's wife filed a counterclaim against Home Federal
alleging that she borrowed $750,000 from another financial institution, secured
by a deed of trust on her principal residence, the proceeds of which were paid
to Home Federal for application on a debt owed by one of her husband's
corporations, claiming that officers of Home Federal promised to resume making
loans to her husband's corporation after the payment. Home Federal and its
officers vigorously deny all of her allegations. Home Federal filed a motion for
summary judgment and dismissal of the counterclaim. The motion for summary
judgment was heard in the Superior Court division of the Mecklenburg County
General Court of Justice in April 1998; however, an order has not been entered.
In June 1998, Home Federal removed this case to the United States Bankruptcy
Court for the Western District of North Carolina, Charlotte Division, due to the
fact that the defendant was the debtor in a pending bankruptcy case. Home
Federal believes it has strong defenses to the defendant's counterclaim.
In February 1997, two companies affiliated with those referred to in the
first paragraph above filed an additional action against two executive officers
of Home Federal and against an officer of another financial institution. The
action was removed from the state court to the United States Bankruptcy Court
for the Western District of North Carolina. At the same time, the borrower, who
is affiliated with all of these companies, also filed an action in the Superior
Court of Mecklenburg County, North Carolina against the two executive officers
of Home Federal and against an officer of another financial institution. The
Complaints in both actions assert virtually identical claims. The plaintiffs in
both lawsuits allege that the officers of both financial institutions engaged in
a conspiracy to wrongfully declare loans to be in default so as to eliminate
those companies as borrowers of Home Federal. Plaintiffs claim actual damages,
treble damages, and punitive damages together with interest, attorneys' fees,
and
25
other costs. Plaintiffs allege misrepresentation, breach of fiduciary duty,
constructive fraud, interference with business expectancy, wrongful bank account
set-off, and unfair and deceptive acts and practices. The action pending in the
bankruptcy court has been stayed. All defendants filed motions for summary
judgment in the state court action which were granted, and that lawsuit was
dismissed in January 1998 by the Superior Court of Mecklenburg County. The
plaintiff appealed the order granting summary judgment to the North Carolina
Court of Appeals. In July 1998, the defendants removed the state court case to
the United States Bankruptcy Court for the Western District of North Carolina,
Charlotte Division, due to the fact that the plaintiff was a debtor in a pending
bankruptcy case. As a result of the removal, the North Carolina Court of Appeals
entered an order staying further proceedings in the North Carolina Court of
Appeals in August 1998. Home Federal has agreed to indemnify both of its
officers with respect to costs, expense, and liability which might arise in
connection with both of these cases.
In July 1997, the above borrower and affiliated companies filed an
additional action against HFNC, Home Federal, and the other financial
institution referred to in the paragraph above, alleging that previous judgments
in favor of Home Federal and the other financial institution obtained in prior
litigation were obtained by the perpetration of fraud on the Bankruptcy Court,
U.S. District Court, and the Fourth Circuit Court of Appeals. The plaintiffs are
seeking to have the judgments set aside on that basis. All defendants filed
motions for summary judgment and dismissal which were granted, and the lawsuit
was dismissed on September 24, 1998. The borrower, individually, has appealed
the Order dismissing the lawsuit to the Fourth Circuit Court of Appeals. That
appeal is pending.
Management continues to deny any liability in the above-described cases and
continues to vigorously defend against the claims. However, there can be no
assurance of the ultimate outcome of the litigation, or the range of potential
loss, if any.
The Corporation and the Banks are defendants in certain other claims and
legal actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these other matters is not expected to have a material adverse effect on the
consolidated operations, liquidity or financial position of the Corporation or
the Banks.
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates of financial instruments are made at a specific point
in time, based on relevant market information and information about the
financial instrument. These estimates do not reflect any premium or discount
that could result from offering for sale at one time the Corporation's entire
holdings of a particular financial instrument. Because no market exists for a
significant portion of the Corporation's financial instruments, fair value
estimates are based on judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in nature and
involve uncertainties and matters of significant judgment and therefore cannot
be determined with precision. Changes in assumptions could significantly affect
the estimates. Where information regarding the fair value of a financial
instrument is available, those values are used, as is the case with investment
securities and residential mortgage loans. In these cases, an open market exists
in which those financial instruments are actively traded.
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. For example, First Charter has a substantial trust
department that contributes net fee income annually. The trust department is not
considered a financial instrument, and its value has not been incorporated into
the fair value estimates. Other significant assets and liabilities that are not
considered financial assets or liabilities include the mortgage broker
operations and premises and equipment. In addition, tax ramifications related to
the realization of the unrealized gains and losses can have a significant effect
on fair value estimates and have not been considered in any of the estimates.
26
The Corporation's fair value methods and assumptions are as follows:
Cash and due from banks, federal funds sold, interest bearing bank
deposits, accrued interest receivable, and accrued interest payable -
the carrying value is a reasonable estimate of fair value due to the
short term nature of these financial instruments.
Securities available for sale and investment securities held to
maturity - fair value is based on available quoted market prices or
quoted market prices for similar securities if a quoted market price is
not available.
Loans - the carrying value for variable rate loans that are performing
is a reasonable estimate of fair value due to contractual interest
rates being based on prime. Fair value for fixed rate loans is
estimated based upon discounted future cash flows using discount rates
comparable to rates currently offered for such loans. The fair value of
nonperforming loans is based on the book value of each loan, less an
applicable reserve for credit losses. The reserve for credit losses is
determined on a loan by loan basis for nonperforming assets based on
one or a combination of the following: external appraisals, internal
assessments using available market information and specific borrower
information, or discounted cash flow analysis.
Deposit accounts -the fair value of certificates of deposit is
estimated using rates currently offered for deposits of similar
remaining maturities. The fair value of all other deposit account types
is the amount payable on demand at year-end.
Other borrowings - the carrying value for shorter-term borrowings is a
reasonable estimate of fair value because these instruments are
generally payable in 90 days or less. The fair value for borrowings
with maturities greater than one year is estimated based upon
discounted future cash flows using a discount rate comparable to the
current market rate for such borrowings.
Commitments to extend credit and standby letters of credit - the large
majority of commitments to extend credit and standby letters of credit
are at variable rates and/or have relatively short terms to maturity.
Therefore, the fair value of these financial instruments is considered
to approximate the carrying value.
Based on the limitations, methods, and assumptions noted above, the
following table presents the carrying amounts and fair values of the
Corporation's financial instruments at December 31, 1997 and 1996:
December 31,
----------------------------------------------------------
(Dollars in thousands) 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
----------------------------------------------------------
Financial Assets:
Cash and due from banks................................. $ 35,392 $ 35,392 $ 36,529 $ 36,529
Federal funds sold...................................... 8,195 8,195 25,946 25,946
Interest bearing bank deposits.......................... 15,143 15,143 18,777 18,777
Investment securities held to maturity.................. -- -- 13,940 13,979
Securities available for sale........................... 315,565 315,565 325,825 325,825
Loans, net of allowance for loan losses................. 1,246,228 1,254,204 1,108,311 1,107,452
Financial Liabilities:
Deposits................................................ 1,059,262 1,054,762 1,013,696 1,015,271
Other borrowings........................................ 350,079 348,391 309,895 304,729
See note 11 for fair value information on derivative financial
instruments used by the Corporation at December 31, 1997 and 1996.
27
(18) REGULATORY MATTERS
The Corporation and the Banks are subject to various regulatory capital
requirements administered by federal and state banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Corporation and the Banks must meet specific capital guidelines that involve
quantitative measures of assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The capital amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Banks to maintain minimum amounts and ratios
(set forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to adjusted average assets (as defined). Management believes, as of
December 31, 1997, that the Corporation and the Banks meet all capital adequacy
requirements to which they are subject.
As of December 31, 1997, the most recent notifications from the
Corporation's various regulators categorized the Corporation, First Charter,
Home Federal, and Union, respectively, as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized,
each entity must maintain minimum total risk-based, Tier I risk-based, and Tier
I leverage ratios as set forth in the table. There are no conditions or events
since that notification that management believes have changed any of the
institutions' categories.
28
The Corporation's and each Bank's actual capital amounts and ratios are also
presented in the table below:
To Be Well Capitalized
For Capital Under Current Prompt
Adequacy Purposes Corrective Action Provisions
Actual ------------------- ----------------------------
----------------- Minimum Minimum
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
--------- ----- --------- ----- --------- -----
At December 31, 1997:
Total Capital (to Risk Weighted Assets)
Consolidated........................... $ 249,342 23.21% $ 85,935 8.00% $ 107,418 10.00%
First Charter National Bank............ 55,804 13.00 34,337 8.00 42,921 10.00
Home Federal........................... 153,020 30.60 40,010 8.00 50,012 10.00
Bank of Union.......................... 18,178 13.22 11,002 8.00 13,753 10.00
Tier I Capital (to Risk Weighted Assets)
Consolidated........................... $ 235,927 21.98% $ 42,934 4.00% $ 64,400 6.00%
First Charter National Bank............ 50,439 11.77 17,135 4.00 25,703 6.00
Home Federal........................... 146,789 29.35 20,005 4.00 30,007 6.00
Bank of Union.......................... 16,459 11.98 5,501 4.00 8,252 6.00
Tier I Capital (to Adjusted Average Assets)
Consolidated........................... $ 235,927 14.94% $ 63,156 4.00% $ 78,945 5.00%
First Charter National Bank............ 50,439 9.79 20,614 4.00 25,768 5.00
Home Federal........................... 146,789 16.61 35,359 4.00 44,199 5.00
Bank of Union.......................... 16,459 9.37 7,027 4.00 8,783 5.00
At December 31, 1996:
Total Capital (to Risk Weighted Assets)
Consolidated........................... $ 236,536 24.75% $ 76,450 8.00% $ 95,552 10.00%
First Charter National Bank............ 54,506 15.03 29,015 8.00 36,269 10.00
Home Federal........................... 173,133 36.49 37,960 8.00 47,450 10.00
Bank of Union.......................... 15,850 14.04 9,034 8.00 11,289 10.00
Tier I Capital (to Risk Weighted Assets)
Consolidated........................... $ 224,623 23.51% $ 38,225 4.00% $ 57,337 6.00%
First Charter National Bank............ 49,948 13.74 14,544 4.00 21,816 6.00
Home Federal........................... 167,227 35.24 18,980 4.00 28,470 6.00
Bank of Union.......................... 14,439 12.79 4,516 4.00 6,774 6.00
Tier I Capital (to Adjusted Average Assets)
Consolidated........................... $ 224,623 14.86 % $ 60,480 4.00 % $ 75,600 5.00%
First Charter National Bank............ 49,948 11.02 18,130 4.00 22,663 5.00
Home Federal........................... 167,227 19.48 34,345 4.00 42,932 5.00
Bank of Union.......................... 14,439 9.31 6,207 4.00 7,759 5.00
(19) FIRST CHARTER CORPORATION (PARENT COMPANY)
The principal assets of the Parent Company are its investment in the Banks,
and its principal source of income is dividends from the Banks. Certain
regulatory and other requirements restrict the lending of funds by the Banks to
the Parent Company and the amount of dividends which can be paid to the Parent
Company. In addition, certain regulatory agencies may prohibit the payment of
dividends by the Banks if they determine that such payment would constitute an
unsafe or unsound practice. At December 31, 1997, the Banks had available
undivided profits of approximately $11,878,000 for payment of dividends without
obtaining prior regulatory approval. Accordingly, at December 31, 1997,
approximately $223,174,000 of the Parent Company's $235,052,000 investment in
subsidiaries is restricted as to transfer to the Parent Company without
obtaining prior regulatory approval.
29
The Parent Company's balance sheet data as of December 31, 1997 and 1996
and related income and cash flow statement data for each of the years in the
three-year period ended December 31, 1997 are as follows:
(Dollars in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA:
Cash..................................................... $ 375 $ 1,441
Securities available for sale............................ 8,569 4,072
Investment in subsidiaries............................... 235,052 254,267
Receivable from subsidiaries............................. 1,700 1,200
Premises and equipment................................... 316 553
Other assets............................................. 1,826 1,010
----------------------------
$ 247,838 $ 262,543
============================
Accrued liabilities...................................... $ 3,929 $ 29,762
Shareholders' equity..................................... 243,909 232,781
----------------------------
$ 247,838 $ 262,543
============================
INCOME STATEMENT DATA:
Dividends from subsidiaries.............................. $ 111,905 $ 80,513 $ 3,800
Other operating income (expense)......................... (1,669) (14) (709)
---------------------------------------------
Income before equity in undistributed net
income of subsidiaries............................... 110,236 80,499 3,091
Equity in undistributed net income of subsidiaries....... (91,065) (63,066) 12,787
---------------------------------------------
Net income ..................................................... $ 19,171 $ 17,433 $ 15,878
=============================================
CASH FLOW STATEMENT DATA:
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 19,171 $ 17,433 $ 15,878
Net gain on securities available for sale transactions... (752) (265) --
Dividends on unrealized ESOP & MRRP
shares, net.......................................... (9,550) (6,395) --
Amortization of unearned stock compensation.............. 5,205 3,764 425
Increase (decrease) in accrued liabilities............... 1,826 (188) 750
Increase in other assets................................. (1,035) (991) (1)
Increase in receivable from subsidiaries................. (500) (405) (195)
Increase in investment in subsidiaries................... 90,773 63,066 (15,419)
---------------------------------------------
Net cash provided by operating activities................ 105,138 76,019 1,438
---------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of capital stock of subsidiaries................ -- -- (168,363)
Purchase of securities available for sale................ (3,444) (762) (906)
Proceeds from sale of securities available for sale...... 1,311 733 --
Purchase of premises and equipment....................... (2) -- (1)
Proceeds from sale of premises and equipment............. 239 30 5
---------------------------------------------
Net cash provided (used) by investing activities......... (1,896) 1 (169,265)
---------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of common stock................................. (1,320) (486) (628)
Purchases of restricted stock from benefit plans......... (17,707) (17,707) --
Proceeds from issuance of common stock upon
exercise of stock options............................ 1,280 1,390 577
Proceeds from note payable............................... 28,000 28,000 --
Repayment of note payable................................ (28,000) -- --
Pre-merger transactions of pooled banks.................. 467 2 171,070
Cash dividends paid...................................... (87,537) (86,846) (2,618)
---------------------------------------------
Net cash used by financing activities.................... (104,817) (75,647) 168,401
---------------------------------------------
Net increase (decrease) in cash...................... (1,575) 373 574
Cash at beginning of year............................ 1,950 1,068 494
---------------------------------------------
Cash at end of year...................................... $ 375 $ 1,441 $ 1,068
=============================================
30
(20) SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
1997
- ----------------------------------------------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
(Dollars in thousands, except income per share) QUARTER QUARTER QUARTER QUARTER TOTAL
- ----------------------------------------------------------------------------------------------------------------
Total interest income............................ $ 29,719 $ 30,221 $ 31,346 $ 31,844 $ 123,130
Total interest expense........................... 14,515 15,735 16,329 16,248 62,827
-------------------------------------------------------------
Net interest income.............................. 15,204 14,486 15,017 15,596 60,303
Provision for loan losses........................ 648 348 733 955 2,684
Total noninterest income......................... 2,375 2,566 5,658 4,483 15,082
Total noninterest expense........................ 10,041 9,349 9,530 13,845 42,765
-------------------------------------------------------------
Net income before income taxes................... 6,890 7,355 10,412 5,279 29,936
Income taxes..................................... 2,334 2,508 3,720 2,203 10,765
-------------------------------------------------------------
Net income....................................... $ 4,556 $ 4,847 $ 6,692 $ 3,076 $ 19,171
=============================================================
Per share data:
Basic income per share........................... $ 0.25 $ 0.27 $ 0.37 $ 0.17 $ 1.06
=============================================================
Diluted income per share......................... $ 0.25 $ 0.26 $ 0.36 $ 0.16 $ 1.03
=============================================================
1996
- -----------------------------------------------------------------------------------------------------------------
First Second Third Fourth
(Dollars in thousands, except income per share) Quarter Quarter Quarter Quarter Total
- -----------------------------------------------------------------------------------------------------------------
Total interest income............................ $ 28,062 $ 29,151 $ 29,637 $ 29,521 $ 116,371
Total interest expense........................... 13,307 14,127 14,482 15,500 57,416
--------------------------------------------------------------
Net interest income.............................. 14,755 15,024 15,155 14,021 58,955
Provision for loan losses........................ 826 11 580 64 1,481
Total noninterest income......................... 1,835 2,200 1,910 2,211 8,156
Total noninterest expense........................ 10,979 9,113 9,910 9,167 39,169
--------------------------------------------------------------
Net income before income taxes................... 4,785 8,100 6,575 7,001 26,461
Income taxes..................................... 1,568 2,868 2,192 2,400 9,028
--------------------------------------------------------------
Net income....................................... $ 3,217 $ 5,232 $ 4,383 $ 4,601 $ 17,433
==============================================================
Per share data:
Basic income per share........................... $ 0.18 $ 0.28 $ 0.24 $ 0.25 $ 0.95
==============================================================
Diluted income per share......................... $ 0.18 $ 0.28 $ 0.23 $ 0.25 $ 0.94
==============================================================
31
(21) SUBSEQUENT EVENTS
Home Federal. The Corporation and HFNC entered into a definitive agreement
and plan of merger (the "Merger Agreement") dated as of May 17, 1998, as amended
and restated as of July 29, 1998, pursuant to which HFNC merged with and into
the Corporation (the "Merger"). HFNC, a North Carolina corporation, was a
savings and loan holding company organized in August 1995 in connection with the
conversion of Home Federal from mutual to stock form (the "Conversion"). The
Conversion was effected on December 28, 1995, at which time Home Federal
converted to a federal stock savings and loan association and became a
wholly-owned subsidiary of HFNC. Home Federal conducts its business from its
main office, eight branch offices, and a loan origination office, all located in
Mecklenburg County, North Carolina. During 1999, Home Federal will be merged
into First Charter, at which time Home Federal's offices will become First
Charter branch locations. At September 30, 1998, HFNC had total consolidated
assets of approximately $1.03 billion, total consolidated loans of approximately
$819.5 million, total consolidated deposits of approximately $437.3 million, and
total consolidated shareholders' equity of $174.2 million. As of September 30,
1998, there were 17,192,500 shares of HFNC common stock outstanding. Each share
of HFNC common stock was converted into 0.57 shares of the Corporation's common
stock.
On September 30, 1998, the Merger was completed and was accounted for as a
pooling-of-interests. Accordingly, all current and prior periods' consolidated
financial statements have been restated to combine the accounts of HFNC with
those of the Corporation. For periods prior to 1997, HFNC's June 30 fiscal
period consolidated financial statements have been combined with the
Corporation's December 31 fiscal period consolidated financial statements. For
purposes of preparing the 1997 consolidated financial statements, HFNC's
year-end was conformed from a June 30 year end to the December 31 year end of
the Corporation. In conforming the fiscal periods, the results of operations of
HFNC for six months ended June 30, 1997 are included in both the December 31,
1996 fiscal period and the December 31, 1997 fiscal period of the Corporation.
As a result, $90,320,000 was reversed from shareholders' equity in 1997
comprised of the following HFNC elements for the six months ended June 30, 1997
(in thousands):
Net income:
Net interest income after provision for loan losses.................... $ 14,751
Noninterest income..................................................... 569
Noninterest expense.................................................... 8,976
Taxes.................................................................. 2,440
---------
Net income............................................................. 3,904
---------
Other changes in shareholders' equity:
Shares released from ESOP and restricted stock trusts.................. 3,243
Purchase of shares by ESOP and restriced stock trusts.................. (17,707)
Cash dividends......................................................... (80,916)
Unrealized gains on securities available for sale, net................. 1,356
Other.................................................................. (200)
---------
Total other changes in shareholders' equity............................ (94,224)
---------
Total equity adjustment to conform fiscal periods in 1997.................. $ 90,320
=========
In presenting the statement of shareholders' equity for the year ended
December 31, 1996, the changes in shareholders' equity (other than net income)
occurring during the six months ended June 30, 1997 are presented as a single
line, and the components are set forth under "other changes in
32
shareholders' equity" above. Such changes impacting the statement of
shareholders' equity for the year ended December 31, 1995 were not significant,
and therefore are not presented separately.
Separate results of operations of the combined entities for the years
ended December 31, 1997, 1996 and 1995 are as follows (dollars in thousands,
except for per share data):
Years Ended December 31,
------------------------------------------------------------------------------------
1997 1996 1995
-------------------------- ---------------------------- ----------------------------
Corp- Corp- Corp-
oration HFNC Restated oration HFNC Restated oration HFNC Restated
-------------------------- ---------------------------- ----------------------------
Net interest income........ 31,203 29,100 60,303 28,110 30,845 58,955 26,099 24,266 50,365
Net income................. 8,401 10,770 19,171 10,069 7,364 17,433 8,304 7,574 15,878
Basic income per share..... 0.91 0.69 1.06 1.10 0.46 0.95 0.95 N/A 0.95
Diluted income per share... 0.90 0.66 1.03 1.09 0.45 0.94 0.94 N/A 0.94
33
FIRST CHARTER CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
First Charter Corporation (the "Corporation") is a multi-bank holding
company established as a North Carolina Corporation in 1983, with three wholly
owned bank subsidiaries, First Charter National Bank ("First Charter"), Bank of
Union ("Union") and Home Federal Savings and Loan Association ("Home Federal")
(collectively referred to as the "Banks"). In September 1998, Union was merged
into First Charter. The Corporation's principal executive offices are located
in Concord, North Carolina. First Charter is a full-service bank and trust
company with sixteen offices located in Cabarrus, Rowan, Cleveland, Rutherford
and northern Mecklenburg Counties, North Carolina. Union is a full-service bank
with five offices located in Union and southern Mecklenburg Counties, North
Carolina.
Union was acquired by the Corporation on December 21, 1995. In
addition, on December 22, 1997, the Corporation acquired Carolina State Bank
("CSB") through the merger of CSB into First Charter. CSB was a state-charted
commercial bank with four banking offices in Cleveland and Rutherford Counties,
North Carolina.
These offices now operate as First Charter offices.
On September 30, 1998, the Corporation merged with HFNC Financial
Corp. ("HFNC"), the parent company of Home Federal. Home Federal is a federally
chartered savings and loan association headquartered in Charlotte, North
Carolina with 9 offices in Mecklenburg County, North Carolina.
Each of these mergers was accounted for as a pooling of interests and,
accordingly, all financial data for the periods prior to the respective dates
of the mergers has been restated to combine the accounts of Union, CSB and Home
Federal with those of the Corporation. In the fourth quarter of 1997, the
Corporation recognized pretax charges of $3.4 million associated with
completing the acquisition of CSB.
Through their branch locations, the Banks provide a wide range of
banking products, including interest bearing and non-interest bearing checking
accounts; "Money Market Rate" accounts; certificates of deposit; individual
retirement accounts; overdraft protection; commercial, consumer, agriculture,
real estate, residential mortgage and home equity loans; personal and corporate
trust services; safe deposit boxes; and automated banking. In addition, through
a subsidiary of First Charter, the Banks also offer discount brokerage
services, insurance and annuity sales and financial planning services pursuant
to a third party arrangement with UVEST Investment Services.
The following discussion and analysis should be read in conjunction
with the consolidated financial statements of the Corporation and the notes
thereto, as restated to reflect the aforementioned poolings of interests. In
addition, the following discussion contains certain forward-looking statements.
See "Factors that May Affect Future Results."
34
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
1997 VERSUS 1996
OVERVIEW
The Corporation earned $19.2 million or $1.06 basic income per share
in 1997, a 10.0% increase from $17.4 million or $0.95 basic income per share in
1996. Excluding the nonrecurring charges associated with the acquisition of
CSB, 1997 earnings per share increased 23.5% to $1.18 per share compared to
1996. Key factors contributing to the increase in net income, excluding the
nonrecurring charges, were an increase of 2.3% in net interest income and an
increase in noninterest income of 85%. These increases were partially offset by
an increase of 81% in the provision for loan losses and an increase of 9.2% in
noninterest expense. Earnings in 1997, excluding the nonrecurring charges,
equate to a return on average assets of 1.21% for 1997, compared to 1.16% for
1996, and a return on average equity of 7.47% in 1997, versus 6.20% in 1996.
Total assets at December 31, 1997, were $1.67 billion, up 6.3% from
the level at year-end 1996. Gross loans increased 12.3% to $1.27 billion and
total deposits increased 4.5% to $1.06 billion.
The following sections discuss the Corporation's strategy and status
in the areas of liquidity, asset-liability management and capital resources.
LIQUIDITY
Liquidity is the ability to maintain cash flows adequate to fund
operations and meet obligations and other commitments on a timely and
cost-effective basis. Liquidity is provided by the ability to attract deposits,
flexible repricing schedules in a sizable portion of the loan portfolio,
current earnings, a strong capital base and the ability to use alternative
funding sources that complement normal sources. Management's asset-liability
policy is to maximize the net interest income while continuing to provide
adequate liquidity to meet continuing loan demand and withdrawal requirements
and to service normal operating expenses.
If additional funding sources were needed, the Banks have access to
federal fund lines at correspondent banks and borrowings from the Federal
Reserve discount window. In addition to these sources, the Banks are members of
the Federal Home Loan Bank ("FHLB") System, which provides access to FHLB
lending sources. At December 31, 1997, the Banks had three available lines of
credit with the FHLB totaling $302.5 million with $65.6 million available.
Another source of liquidity is the securities available for sale
portfolio. See "Balance Sheet Analysis - Securities Available for Sale" for a
further discussion. Management believes the Banks' sources of liquidity are
adequate to meet loan demand, operating needs and deposit withdrawal
requirements.
ASSET-LIABILITY MANAGEMENT AND INTEREST RATE SENSITIVITY
The primary objective of the Corporation's asset-liability management
strategy is to reduce the risk of a significant decrease in net interest income
caused by interest rate changes without unduly penalizing current earnings. One
method used to manage interest rate sensitivity is to measure, over various
time periods, the interest rate sensitivity positions, or gaps; however, this
method addresses only the magnitude of
35
timing differences and does not address earnings or market value. Management
uses an earnings simulation model to assess the amount of earnings at risk due
to changes in interest rates. This model is updated quarterly and is based on a
range of interest rate scenarios. Under the Corporation's policy prior to the
merger with HFNC, the limit for interest rate risk is 10% of net interest margin
when considering an increase or decrease in interest rates of 300 basis points
over a twelve-month period. Management believes this method more accurately
measures interest rate risk. These targeted guidelines were achieved during 1997
prior to the merger with HFNC. With the merger of HFNC in September 1998,
interest rate risk increased above 10% to approximately 13.2% at December 31,
1997. Management is developing a plan to reduce the Corporation's interest rate
risk exposure.
The Banks' balance sheets are liability sensitive, meaning that in a
given period there will be more liabilities than assets subject to immediate
repricing as market rates change. Because immediately rate sensitive interest
bearing liabilities exceed rate sensitive assets, the earnings position could
improve in a declining rate environment and could deteriorate in a rising rate
environment, depending on the correlation of rate changes in these two
categories. At December 31, 1997 total rate sensitive liabilities due within one
year were $950.9 million compared to rate sensitive assets of $465.7 million,
for a negative one-year cumulative gap of $485.2 million. Interest sensitivity
of the Corporation's balance sheet as of a specific date is not necessarily
indicative of the Corporation's position on other dates. Management is
developing a plan to reduce the Corporation's negative one-year cumulative gap.
From time to time, the Corporation may use derivative financial
instruments including futures, forwards, interest rate swaps, option contracts,
and other financial instruments with similar characteristics. The Corporation
currently has an interest rate floor transaction arrangement which it uses as a
hedge against variable rate loans. This interest rate floor transaction has a
notional amount of $20 million and a floor rate of 8.5%, compared to the
current index of 8.5%, maturing on January 23, 2000. Additionally, the
Corporation is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve to varying degrees elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. Commitments to extend credit are agreements to
lend to a customer so long as there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates
and may require collateral from the borrower if deemed necessary by the
Corporation. Standby letters of credit are conditional commitments issued by
the Corporation to guarantee the performance of a customer to a third party up
to a stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not
recorded as an asset or liability by the Corporation until the instrument is
exercised, see "Balance Sheet Analysis - Loans".
36
The following table presents the scheduled maturity of market risk
sensitive instruments at December 31, 1997:
(Dollars in thousands)
There
Maturing in: 1998 1999 2000 2001 2002 -after Total
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Debt securities..... $ 15,787 $ 13,445 $ 21,237 $ 14,503 $ 40,500 $179,988 $ 285,460
Loans............... 275,050 164,055 168,916 138,722 133,217 366,268 1,246,228
-----------------------------------------------------------------------------------------
Total............ $ 290,837 $177,500 $190,153 $153,225 $173,717 $546,256 $1,531,688
=========================================================================================
LIABILITIES
Savings, NOW
and IMMA's....... $ 459,174 $ -- $ -- $ -- $ -- $ -- $ 459,174
CD's................ 418,525 135,416 37,860 4,084 4,019 184 600,088
Short-term
borrowings....... 245,546 -- -- -- -- -- 245,546
Long-term
borrowings....... -- 260 1,143 -- 102,600 530 104,533
-----------------------------------------------------------------------------------------
Total.......... $1,123,245 $135,676 $ 39,003 $ 4,084 $106,619 $ 714 $1,409,341
=========================================================================================
The following table presents the average interest rate and estimated
fair value of market risk sensitive instruments at December 31, 1997:
Average Estimated
(Dollars in thousands) Total Interest Rate Fair Value
- -------------------------------------------------------------------------------------
ASSETS
Debt securities.......... $ 285,460 7.11% $ 288,152
Loans.................... 1,246,228 8.40 1,254,204
------------------------------------------------------
Total .............. $ 1,531,688 8.16 $ 1,542,356
======================================================
LIABILITIES
Savings, NOW
and IMMA's............. $ 459,174 3.28 $ 454,648
CD's..................... 600,088 5.85 599,814
Short-term
borrowings............. 245,546 5.77 245,546
Long-term
borrowings............. 104,533 5.42 102,845
------------------------------------------------------
Total............... $ 1,409,341 4.97 $ 1,402,853
======================================================
CAPITAL RESOURCES
At December 31, 1997, total shareholders' equity was $243.9 million, a
4.8% increase from December 31, 1996. The increase in capital is primarily
attributable to 1997 earnings. Cash dividends declared per share in 1997 were
$5.15 compared to $5.25 in 1996.
The principal asset of the parent company is its investment in the
Banks. Thus, the parent company derives its principal source of income through
dividends from the Banks. Certain regulatory and other requirements restrict
the lending of funds by the Banks to the parent company and the amount of
dividends which can be paid to the parent
37
company. In addition, certain regulatory agencies may prohibit the payment of
dividends by the Banks if they determine that such payment would constitute an
unsafe or unsound practice. At December 31, 1997, the Banks had available
undivided profits of approximately $11.9 million for payments of dividends
without obtaining prior regulatory approval.
The Corporation and the Banks must comply with regulatory capital
requirements established by the applicable federal regulatory agencies. Under
the Federal Reserve Board (the "FRB") standards, the Corporation must maintain
a minimum ratio of Tier I Capital (as defined) to total risk-weighted assets of
4.00% and a minimum ratio of Total Capital (as defined) to risk-weighted assets
of 8.00%. Tier I Capital is comprised of total shareholders' equity calculated
in accordance with generally accepted accounting principles less certain
intangible assets, less unrealized gains or losses on securities available for
sale and Total Capital is comprised of Tier I Capital plus certain adjustments,
the largest of which for the Corporation is the general allowance for loan
losses (up to 1.25% of risk weighted assets). Tier 1 Capital must consist of at
least 50% of Total Capital. Risk-weighted assets refer to the on-and
off-balance sheet exposures of the Corporation adjusted for their related risk
levels using amounts set forth in FRB regulations.
In addition to the aforementioned risk-based capital requirements, the
Corporation is subject to a leverage capital requirement, requiring a minimum
ratio of Tier I Capital (as defined previously) to total adjusted average
assets of 3% to 5%.
At December 31, 1997, the Corporation and the Banks were in compliance
with all existing capital requirements. The Corporation's consolidated capital
requirements are summarized in the table below:
Risk-Based Capital
----------------------------------------------------
Leverage Capital Tier 1 Capital Total Capital
- ---------------------------------------------------------------------------------------------------------------------------
Amount Percentage (1) Amount Percentage (2) Amount Percentage (2)
- ---------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Actual..................... $235,927 14.94% $235,927 21.98% $249,342 23.21%
Required................... 63,156 4.00 42,934 4.00 85,935 8.00
Excess..................... 172,771 10.94 192,993 17.98 163,407 15.21
(1) Percentage of total adjusted average assets. The FRB minimum
leverage ratio requirement is 3% to 5%, depending on the
institution's composite rating as determined by its
regulators. The FRB has not advised the Corporation of any
specific requirement applicable to it.
(2) Percentage of risk-weighted assets.
38
REGULATORY RECOMMENDATIONS
Management is not presently aware of any current recommendations to
the Corporation or to the Banks by regulatory authorities which, if they were
to be implemented, would have a material effect on the Corporation's liquidity,
capital resources, or operations.
BALANCE SHEET ANALYSIS
SECURITIES AVAILABLE FOR SALE
Securities available for sale are a component of the Corporation's
asset-liability management strategy and may be sold in response to liquidity
needs, changes in interest rates, changes in prepayment risk, and other
factors. They are accounted for at fair value with unrealized gains and losses
recorded as a separate component of shareholders' equity.
Pursuant to the Financial Accounting Standards Board (FASB)'s
Statement of Financial Accounting Standards (Standard) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities", following the acquisition
of CSB, all investment securities at CSB were reclassified to securities
available for sale. During 1997, as maturities, sales, or paydowns occurred on
securities, the proceeds were utilized to meet loan demand and to reinvest in
additional securities. During the latter part of 1997, in anticipation of lower
yields, approximately $30 million of securities that had short-term maturities
or were subject to repayment were sold. These proceeds were reinvested
primarily in U. S. government agency securities with higher spreads to the
treasury yield curve and callable within two to five years. Additionally,
throughout 1997, in-state municipal securities (maturity range of five to
fifteen years) were purchased to enhance tax equivalent net interest income.
At December 31, 1997, securities available for sale were $315.6
million or 18.9% of total assets, compared to $325.8 million, or 20.7% of total
assets, at year-end 1996. The fair value of these assets was approximately $9.0
million and $9.2 million above their amortized cost at December 31, 1997 and
1996, respectively. The tax equivalent average yield on the securities
available for sale portfolio was 6.72% for 1997 and 6.75% for 1996. The average
life of the portfolio was 10.06 years at December 31, 1997 compared to 9.00
years at year-end 1996.
INVESTMENT SECURITIES
As a result of the reclassification of CSB's investment securities to
securities available for sale subsequent to the acquisition of CSB, there was
no balance in investment securities at December 31, 1997. Investment securities
totaled $13.9 million or 0.9% of total assets at December 31, 1996.
The average yield earned on investment securities in 1997 was 5.80%
compared to 5.85% in 1996, with an average maturity of 1.53 years at December
31, 1996.
LOANS
As a result of continued strong loan demand during 1997, gross loans
increased 12.3% to $1.27 billion at December 31, 1997, from $1.13 billion at
December 31, 1996, with the majority of the growth originating in the single
family residential mortgage portfolio. While the Corporation does anticipate
that loan growth may increase in the future, it does not anticipate that loan
growth will increase at the same rate as experienced in the previous years.
The loan portfolio at December 31, 1997 was composed of 6.4%
commercial, financial, and agricultural loans, 10.5% real estate construction
loans, 76.1% real estate mortgage loans, and 7.0% installment loans. This
compares to a composition of 5.6% commercial, financial, and agricultural, 9.1%
39
real estate construction, 77.1% real estate mortgage, and 8.2% installment at
December 31, 1996. Approximately $104.8 million of the real estate mortgage
loans are loans for which the principal source of repayment comes from the sale
of real estate. The remaining $993.0 million of real estate mortgage loans are
(i) other commercial loans for which the primary source of repayment is derived
from the ongoing cash flow of the business and which are also collateralized by
real estate - $240.2 million, (ii) personal installment loans which are
collateralized by real estate - $53.9 million, (iii) home equity loans - $62.0
million, and (iv) individual residential mortgage loans - $636.9 million.
The Corporation's primary market area includes the states of North and
South Carolina, and predominately centers on the Metro region of Charlotte,
North Carolina. At December 31, 1997, the majority of the total loan portfolio,
as well as a substantial portion of the commercial and real estate loan
portfolio, were to borrowers within this region. The diversity of the region's
economic base tends to provide a stable lending environment. No significant
concentration of credit risk has been identified due to the diverse industrial
base in the region.
In the normal course of business, there are outstanding various
commitments to extend credit which are not reflected in the consolidated
financial statements. At December 31, 1997, pre-approved but unused lines of
credit for loans totaled $175.2 million and standby letters of credit
aggregated $3.2 million. These amounts represent the Banks' exposure to credit
risk, and in the opinion of management, have no more than the normal lending
risk that the Banks commit to their borrowers. If these commitments are drawn,
the Banks will obtain collateral if it is deemed necessary based on
management's credit evaluation of the borrower. Collateral obtained varies but
may include accounts receivable, inventory, and commercial or residential real
estate. Management expects that these commitments can be funded through normal
operations.
ASSET QUALITY
Nonperforming assets, which consist of foreclosed assets, nonaccrual
loans, and restructured loans, were $10.7 million at December 31, 1997, as
compared to $10.2 million at December 31, 1996. Non-performing assets as a
percentage of loans and foreclosed assets at year-end amounted to 0.85% in 1997
and 0.91% in 1996. Total problem assets (nonperforming assets and loans 90 days
or more past due) amounted to $12.8 million at December 31, 1997 and $10.9
million at December 31, 1996. Total problem assets as a percentage of loans and
foreclosed assets at year end was 1.02% in 1997 and 0.97% in 1996.
The components of nonperforming and problem assets are presented in
the table below:
December 31, December 31,
(Dollars in thousands) 1997 1996
- --------------------------------------------------------
Nonaccrual loans $ 6,119 $ 7,949
Restructured loans 587 643
Other real estate 4,006 1,627
------- -------
Total non-
performing assets 10,712 10,219
Loans 90 days or more
past due and still
accruing 2,109 685
------- -------
Total problem assets $12,821 $10,904
======= =======
Nonaccrual loans decreased primarily due to several residential
construction loans reclassified from nonaccrual to other real estate. Interest
income that would have been recorded on all nonaccrual loans for the year ended
December 31, 1997, had they performed according to their original terms,
amounted to approximately $767,000, a decrease of 45.8% from $1,118,000 for the
year ended December 31, 1996. Interest income on nonaccrual loans
40
included in the results of operations for the years ended December 31, 1997 and
1996, amounted to approximately $136,000 and $155,000, respectively.
Accruing loans 90 days or more past due increased $1.4 million, to
0.17% of gross loans at December 31, 1997, from 0.06% of gross loans at
December 31, 1996. The major components of this increase are the delinquency of
a $900,000 secured loan, several 1-4 family residential mortgages totaling
$342,000, and several commercial loans related to the CSB loan portfolio.
Management's policy for any accruing loan past due greater than 90
days is to perform an analysis of the loan, including a consideration of the
financial position of the borrower(s) and any guarantor(s) as well as the value
of the collateral, and to make an assessment as to whether collectibility of
the principal and the interest appears probable. Based on such a review,
management has determined it is probable that the principal as well as the
accruing interest on these loans will be collected in full.
Other real estate increased to $4.0 million at December 31, 1997 from
$1.6 million at December 31, 1996. The primary reason for the $2.4 million
increase is due to $456,000 of net foreclosure activity related to the CSB loan
portfolio. Seven properties with balances ranging from $7,400 to $250,000
aggregated $456,000 and nine properties from HFNC ranging from $16,000 to
$902,961 aggregated $2.3 million. Based on a review of recent appraisals of
these properties, management has determined that they are properly carried at
the lower of cost or fair value less costs to sell.
CREDIT ADMINISTRATION AND ALLOWANCE FOR LOAN LOSSES
All estimates of the loan portfolio risk, including the adequacy of
the allowance for loan losses, are subject to general and local economic
conditions, among other factors, which are unpredictable and beyond
management's control. Since a significant portion of the loan portfolio is
comprised of real estate loans and loans to area businesses, a continued risk
is that the real estate market and economic conditions could change and could
result in future losses or require increases in the provision for loan losses.
Management currently uses several measures to assess and control the
loan portfolio risk. For example, all loans over a certain dollar amount must
receive an in-depth review by an analyst in the Banks' Credit Administration
department. Any issues regarding risk assessments of those credits are
addressed by the Banks' loan administration and senior credit officer and
factored into management's decision to originate or renew the loan.
Furthermore, large commitments are reviewed and approved by a Senior Loan
Committee comprised of senior management, the senior credit officer and senior
lending officers of the Banks and loans above predetermined amounts are
reviewed by the Loan Committee of the respective Board of Directors. The
Corporation also continues to employ an independent third party risk assessment
group to review the underwriting, documentation and risk grading analysis and
render an annual opinion of the adequacy of the allowances for loan losses.
This third party group reviews all loan relationships above a certain dollar
amount and a sampling of all other credits. The third party's evaluation and
report is shared with Senior Management and the Loan and Audit Committees of
the respective Banks and, ultimately, is reported to the respective Bank and
Corporation Board of Directors.
Management uses the information developed from the procedures
described above in evaluating and grading the loan portfolio. This continual
grading process is used to monitor the credit quality of the loan
41
portfolio and to assist management in determining the appropriate levels of the
allowance for loan losses.
As part of the continual grading process, an analysis is performed
monthly independently from any analysis in conjunction with the origination of
loans. Individual loans are assigned a risk grade based on their credit
quality, which is subject to change as conditions warrant. Any changes in those
risk assessments as determined by the outside risk assessment group is also
considered. Each grade determines the percentage of the outstanding loan
balance allocated to the loan loss reserve. Loans with the weaker credit
quality are individually analyzed to determine a specific allowance which
reflects management's best estimate of the risk associated with each credit. An
estimate of an allowance is made for all other loans in the portfolio based on
their assigned risk grade, type of loan and other matters related to credit
risk. In the allowance for loan loss analysis process, the Banks also aggregate
the loans into pools of similar credits and review the historical loss
experience associated with these pools as additional criteria to allocate the
allowance to each category. The model also takes into consideration off-balance
sheet credit risk.
The allowance for loan losses as a percentage of gross loans
outstanding was 1.20% at December 31, 1997, compared to 1.25% at year-end 1996.
Total problem assets as a percentage of gross loans outstanding was 1.02% at
December 31, 1997, compared to 0.97% at December 31, 1996.
Management considers the December 31, 1997 allowance for loan losses
adequate to cover inherent losses in the Banks' loan portfolio. Management
believes it has established the allowance in accordance with generally accepted
accounting principles and in consideration of the current economic environment.
While management uses the best information available to make evaluations,
future additions to the allowance may be necessary based on changes in economic
and other conditions. Additionally, various regulatory agencies, as an integral
part of their examination process, periodically review the Banks' allowances
for loan losses. Such agencies may require the recognition of additions to the
allowances based on their judgments of information available to them at the
time of their examinations.
DEPOSITS
Total deposits at December 31, 1997 were $1.06 billion, a 4.5%
increase from a 1996 year-end level of $1.01 billion. Average demand deposits
increased $7.3 million or 7.5%; average insured money market accounts increased
$8.6 million or 11.1%; average savings deposits decreased $2.0 million or 1.5%;
and average certificates of deposit increased $25.5 million or 4.4%. The
majority of deposit growth was in certificates of deposit ("CD") products. The
increase in average CD's was primarily attributable to several CD promotions in
1997, which raised new deposits with maturities of nine, eighteen or
twenty-four months, and to the increase in public deposits with maturities of
six months that were opened in 1997.
EARNINGS PERFORMANCE
NET INTEREST INCOME
Net interest income, the difference between total interest income and
total interest expense, is the Corporation's principal source of earnings. For
the year ended December 31, 1997, net interest income was $60.3 million, an
increase of 2.3% from net interest income of $59.0 million in 1996. The
increase is attributable to an increase in the volume of average interest
earning assets of approximately $72.0 million mitigated by a decrease in the
net interest margin (tax adjusted net interest income divided by average
interest earning assets) to 4.12% in 1997 from 4.23% in 1996.
42
The average yield on interest-earning assets was 8.29% in 1997
compared to 8.22% in 1996. The average rate paid on interest-bearing
liabilities was 5.16% in 1997, compared to 5.16% in 1996. The average yield
earned on loans was 8.83% in 1997, compared to 8.86% in 1996. The average rate
paid on interest-bearing deposits was 5.75% in 1997, from 6.66% in 1996. See
"Asset-Liability Management and Interest Rate Sensitivity" for additional
discussion.
PROVISION FOR LOAN LOSSES
The provision for loan losses for 1997 was $2.7 million compared to
$1.5 million in 1996. A portion of the increase in the provision was necessary
to reflect the growth in the Banks' loan portfolio and higher levels of
nonperforming assets. Additionally, a $1.4 million provision for loan losses
was recorded for the CSB loan portfolio in 1997 in recognition of increased
1997 charge-offs and portfolio growth.
Net charge-offs for 1997 were $1.8 million or .16% of average loans
compared to $893,000 million or .09% of average loans in 1996.
NONINTEREST INCOME
Noninterest income was $15.1 million in 1997 compared to $8.2 million
in 1996, for an increase of 84.9%. The increase in other noninterest income is
attributable to higher securities gains due to the sale of equity securities
held by the Corporation, higher service charge income on deposit accounts
resulting from an increase in non-sufficient fund income, higher trust income
due to greater assets under management and higher commissions earned on
brokerage services resulting from increased sales volumes.
NONINTEREST EXPENSE
Excluding the $3.4 million in nonrecurring costs associated with the
acquisition of CSB, total noninterest expense in 1997 was $39.4 million,
compared to $39.2 million in 1996, representing a 0.5% increase. The increase
was primarily attributable to increases in costs associated with salaries and
benefits, occupancy and equipment and other noninterest expense.
Salaries and fringe benefits increased primarily due to higher
full-time equivalents and annual merit increases.
Occupancy and equipment increased approximately $988,000 or 22.2%. A
primary reason for the increase is due to an increase in depreciation expense
in connection with the local area network (LAN) and the wide area network (WAN)
which were added in mid-1996. This technology continues to improve the Banks'
ability to service loan and deposit customers and to gain greater operating
efficiency. Additionally, with the Banks' continued growth, additional office
space was required, thereby the Corporation entered into several leasing
agreements for office space.
Excluding the $3.4 million in costs associated with the acquisition of
CSB, other noninterest expense decreased $2.4 million, or 16.7% in 1997, when
compared to 1996. The three major components of change in this category are
advertising, data processing and professional services. During 1997, the Banks
incurred additional advertising expense primarily related to costs associated
with promoting certificates of deposit and equity line products. Data
processing and professional services costs increased due to the aforementioned
technology added in mid-1996 and throughout 1997. As the Banks continue to grow
and invest in technology, the Corporation anticipates further increases in this
area during 1998.
43
Total income tax expense for 1997 was $10.8 million versus $9.0
million in 1996. The increase is attributable to an increase in taxable income,
slightly offset by an increase in the effective tax rate to 36.0% in 1997 from
34.1% in 1996. The change in the effective rate is primarily attributable to
certain nondeductible merger and acquisition costs incurred in 1997, and an
increase in state income taxes, which were partially offset by an increase in
tax-exempt income from municipal securities in 1997.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
1996 VERSUS 1995
The Corporation earned $17.4 million, or $0.95 basic income per share,
in 1996, a 9.8% increase from $15.9 million, or $1.81 basic income per share in
1995. Key factors contributing to the increase in net income were a 17.1%
increase in net interest income, a reduction in the provision for loan losses,
and the absence in 1996 of pre-tax merger related expenses of $1.1 million
incurred in 1995 in connection with the acquisition of Union. These earnings
equated to a return on average assets of 1.16% for 1996, compared to 1.26% for
1995, and a return on average equity of 6.20% in 1996, versus 6.98% in 1995.
Total assets at December 31, 1996, were $1.57 billion, up 11.2% from
the level at year-end 1995. Gross loans increased 21.1% to $1.13 billion and
total deposits increased 5.2% to $1.01 billion, at December 31, 1996 from their
levels at year-end 1995.
At December 31, 1996, securities available for sale were $325.8
million or 20.7% of total assets compared to 28.2% of total assets at year-end
1995. During 1996, stable interest rates and a growing economy created
increased loan demand. Maturities from both portfolios helped to fund the
increased loan demand. Concurrently, short-term agency securities (less than
one year) and U.S. Treasuries (two years to three years) were purchased to
maintain liquidity while in-state municipal securities (maturity range of five
to fifteen years) were purchased to enhance tax equivalent net interest income.
The fair value of securities available for sale was approximately $9.2 million
above their amortized cost at December 31, 1996. The average yield on the
securities available for sale portfolio was 6.75% for 1996 and 6.36% for 1995.
The average life of the portfolio was 9.00 years at December 31, 1996 compared
to 4.53 years at year-end 1995.
Investment securities held to maturity totaled $13.9 million or 0.9%
of total assets at December 31, 1996. The average yield earned on investment
securities held to maturity in 1996 was 5.85% compared to 7.22% in 1995, with
an average maturity of 1.53 years at December 31, 1996.
The loan portfolio at December 31, 1996 was composed of 5.6%
commercial, financial, and agricultural loans, 9.1% real estate construction
loans, 77.1% real estate mortgage loans, and 8.2% installment loans. This
compares to a composition of 7.2% commercial, 9.0% real estate construction,
75.2% real estate mortgage, and 8.6% installment at December 31, 1995.
Problem assets at December 31, 1996 were $10.9 million, or 1.0% of
gross loans and foreclosed properties, compared to $14.3 million or 1.5% at
December 31, 1995.
44
The components of problem assets are presented in the table below:
December 31, December 31,
(Dollars in thousands) 1996 1995
- -----------------------------------------------------
Nonaccrual loans $ 7,949 $10,497
Restructured loans 643 825
Other real estate 1,627 2,600
------- -------
Total non-
performing assets 10,219 13,922
Loans 90 days or more
past due and still
accruing 685 401
------- -------
Total problem assets $10,904 $14,323
======= =======
Interest income that would have been recorded on nonaccrual loans for
the years ended December 31, 1996 and 1995, had they performed according to
their original terms, amounted to approximately $1,118,000 and $1,911,000,
respectively. Interest income on nonaccrual loans included in the results of
operations for the years ended December 31, 1996 and 1995, amounted to
approximately $155,000 and $268,000, respectively.
Accruing loans 90 days or more past due increased to 0.06% of gross
loans at December 31, 1996 compared to 0.10% of gross loans at December 31,
1995.
Net charge-offs for 1996 were $893,000 or 0.09% of average loans
compared to $1.9 million or 0.23% of average loans in 1995.
Other real estate decreased to $1.6 million at December 31, 1996 from
$2.6 million at December 31, 1995. Included in other real estate is the 1996
reclassification of property totaling $434,500 that was originally purchased
for the construction of a branch location. Management decided not to construct
a branch on this property, and therefore, the carrying value of this property
was reclassified from premises and equipment to other real estate. This
property is currently being marketed and the gain or loss from its sale is not
expected to be significant. Additionally, two residential construction loans
were foreclosed in December 1996.
Total deposits at December 31, 1996 were $1.01 billion, a 5.2% increase
from a 1995 year-end level of $964.0 million. Average noninterest bearing demand
deposits increased $9.9 million or 12.6%; average interest bearing demand
deposits decreased $1.3 million or 1.3%; average insured money market accounts
decreased $9.7 million or 11.1%; average savings deposits increased $9.6 million
or 7.7%; and average CD's increased $494,000 or 0.1%. The majority of deposit
growth was in CD products. The increase in average CD's was primarily
attributable to an increase in public deposits.
For the year ended December 31, 1996, net interest income was $59.0
million, an increase of 17.1% from net interest income of $50.4 million in
1995. The increase is attributable to the investment of proceeds from the HFNC
conversion to stock form of ownership. The decline in the margin is
attributable to more growth in higher yielding deposits, such as CD's, than in
lower yielding deposits, such as NOW and savings deposits.
The average yield on interest-earning assets was 8.22% in 1996
compared to 8.34% in 1995. The average rate paid on interest-bearing
liabilities was 5.16% in 1996, compared to 5.11% in 1995. The average yield
earned on loans was 8.86% in 1996, compared to 9.23% in 1995. The average rate
paid on interest-bearing deposits was 5.00% in 1996, compared to 5.10% in 1995.
The provision for loan losses for 1996 was $1.5 million compared to
$2.3 million in 1995. The decrease in the provision was primarily attributable
to a reduction in net charge-offs and improved asset quality. The allowance for
loan losses as a percentage of gross loans outstanding was 1.26% at December
31, 1996, compared to 1.46% at year-end 1995.
45
Noninterest income was $8.2 million in 1996 compared to $7.1 million
in 1995. The increase in other noninterest income is attributable to higher
securities gains due to the sale of equity securities held by the Corporation,
higher service charge income on deposit accounts resulting from an increase in
non-sufficient fund income and higher mortgage loan income due to increased
loan originations.
Total noninterest expense was $39.2 million in 1996 compared to $31.8
million in 1995, a 23.1% increase. The increase was primarily attributable to
increases in costs associated with salaries and benefits, occupancy and
equipment and other noninterest expense.
Salaries and fringe benefits increased primarily due to the
implementation of HFNC's Management Recognition and Retention Plan and Employee
Stock Ownership Plan in 1996. Other increases were related to higher full-time
equivalents, annual merit increases and higher benefits costs.
Occupancy and equipment increased approximately $790,000 or 21.6% over
1995. This increase was primarily due to an increase in depreciation expense in
connection with the aforementioned LAN and WAN technology additions in 1996 and
in connection with the opening of a full service branch.
Other noninterest expense increased approximately $1.8 million or
14.4% for 1996 when compared to 1995, primarily due to the absence of merger
and acquisition expenses associated with the acquisition of Union in 1995.
These costs included legal, accounting, investment banking, regulatory filings,
proxy printing and solicitation expenses, all of which were incurred during the
fourth quarter of 1995.
Total income tax expense for 1996 was $9.0 million versus $7.5 million
in 1995. The increase is attributable both to an increase in income before
income taxes and an increase in the effective tax rate to 34.1% in 1996 from
31.9% in 1995. The change in the effective rate is primarily attributable to a
decrease in the valuation allowance on deferred tax assets in 1995.
ACCOUNTING AND REGULATORY MATTERS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 130, "Reporting Comprehensive Income." Statement 130 establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general purpose
financial statements. Comprehensive income is the non-shareholder related
change in equity (net assets) of a company during a period from transactions
and other events. The provisions of this statement are effective for fiscal
years beginning after December 15, 1997, including interim periods, and
requires restatement of all prior periods presented. The Corporation adopted
Statement 130 on January 1, 1998, and does not expect any material impact on
the financial condition or results of operations as a result of this new
accounting standard.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which establishes standards
for the way that business enterprises report information about operating
segments in annual financial statements and requires that these enterprises
report selected information about operating segments in interim financial
reports. It also establishes standards for related disclosures about products
and services, geographic areas and major customers. SFAS No. 131 is effective
for periods beginning after December 15, 1997 and requires restatement of all
prior periods presented. The Corporation adopted Statement 131 on January 1,
1998, and does not expect any material impact on the financial condition or
results of operations as a result of this new accounting standard.
46
Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits," does not change
the recognition or measurement associated with pension or postretirement plans.
It standardizes certain disclosures, requires additional information about
changes in the benefit obligations and about changes in the fair value of plan
assets to facilitate analysis, and it eliminates certain disclosures that were
not deemed useful. This Standard is effective for financial statements issued
for periods beginning after December 15, 1997.
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities," establishes accounting and
reporting standards for derivatives and hedging activities. It requires that
all derivatives be included as assets or liabilities in the balance sheet and
that such instruments be carried at fair market value through adjustments to
either other comprehensive income or current earnings or both, as appropriate.
The Corporation is in the process of assessing the impact of this Standard. The
Standard is effective for financial statements issued for all fiscal quarters
of fiscal years beginning after June 15, 1999.
Statement of Financial Accounting Standards No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise," establishes accounting and
reporting standards for certain mortgage banking activities. It conforms the
subsequent accounting for securities retained after the securitization of other
types of assets. The Corporation is in the process of assessing the impact of
this Standard. The Standard is effective for financial statements for the first
fiscal quarter beginning after December 15, 1998.
From time to time, FASB also issues exposure drafts for proposed
statements of financial accounting standards. Such exposure drafts are subject
to comment from the public, to revisions by the FASB and to final issuance by
the FASB as statements of financial accounting standards. Management considers
the effect of the proposed statements on the consolidated financial statements
of the Corporation and monitors the status of changes to issued exposure drafts
and to proposed effective dates.
YEAR 2000 CONSIDERATION
The management's discussion included herein provides an analysis of
the financial condition and results of operations of the Corporation as set
forth in the accompanying supplemental consolidated financial statements of the
Corporation as of December 31, 1997 and 1996, and for each of the years in the
three-year period ended December 31, 1997. These supplemental consolidated
financial statements reflect the September 30, 1998 pooling-of-interest merger
between First Charter Corporation and HFNC Financial Corp. The following
discussion of Year 2000 considerations has been provided based on the
Corporation's status relative to such matters as of September 30, 1998 in order
to provide the most current information relative to this topic.
Year 2000 Compliance
The "Year 2000 Issue" is a general term used to describe the various
problems that may result from the improper processing of dates and
date-sensitive calculations by computers and other machinery as the Year 2000
approaches. These problems generally arise because most computer hardware and
software historically have used only two digits to identify the applicable
year. Since there may be no accommodation for the full four-
47
digit year, computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This error could
result in system failure or miscalculations causing disruption of operations,
including among other things a temporary inability to process customer
transactions, properly accrue interest income and expense or engage in similar
normal business activities. In addition, non-banking systems, such as security
alarms, telephones, vaults, etc. are also subject to malfunction due to their
dependence upon software that utilizes special codes and conventions using the
date field.
State of Readiness
The Corporation recognizes the potentially severe implications of the
Year 2000 Issue. The Board of Directors of the Corporation has approved a Year
2000 Action Plan ("Action Plan") that has been developed in accordance with the
Federal Financial Institutions Examination Council ("FFIEC") guidelines. The
Action Plan consists of five phases: (1) awareness, (2) assessment, (3)
remediation, (4) validation, and (5) implementation. The Corporation has
completed phases 1 and 2 of its Action Plan. In completing phase 2, the
Corporation performed a thorough inventory of its Information Technology ("IT")
and non-IT systems to identify all potential Year 2000 exposed systems and
equipment. The items identified in the inventory were then categorized as
"mission-critical" or "non-mission-critical" depending on the Corporation's
dependence on the system or equipment to perform daily operations and conduct
business. This classification allowed the Corporation to prioritize its efforts
in remediating systems and dealing with third party vendors.
The Corporation is currently working in phases 3, 4 and 5 of the
Action Plan. Since the Corporation generally does not perform in-house
programming of its core operating systems, it is dependent on its third-party
vendors for modifications or conversions of its existing systems to correct the
effects of the Year 2000 Issue. Accordingly, the vast majority of phases 3 and
4 involve receiving system upgrades and installing and testing them in the
Corporation's operating systems and equipment. The Corporation is soliciting
written documentation from all of its software and hardware vendors, as well as
the providers of facilities using imbedded chip technology, with respect to its
Year 2000 compliance status. Upgrades to existing systems and equipment are
currently being installed and tested, such that the Corporation believes that
it may be substantially complete with phases 3 and 4 by December 31, 1998.
The merger with HFNC is not expected to significantly impact the
Action Plan or the Corporation's state of readiness for Year 2000 compliance.
The Corporation is incorporating all of Home Federal's IT and non-IT systems in
all phases of its Year 2000 Action Plan. The Corporation currently plans to
convert all but one of Home Federal's operating systems to the Corporation's
operating systems in March of 1999. The Corporation does not currently plan to
convert Home Federal's mortgage loan system to the Corporation's loan
application system until after January 1, 2000. Accordingly, Home Federal's
mortgage loan operating system, which is operated by a third party service
bureau, is being included in the Corporation's efforts in phases 3, 4 and 5 of
the Action Plan.
The Corporation also has developed a communication and assessment plan
for its customers. Pursuant to this plan, the Corporation is initiating contact
with its key customers to determine such customers' plans with respect to the
Year 2000 Issue and the Corporation's vulnerability to any such customer's
failure to remediate its own Year 2000 Issue. As most corporate customers
depend on computer systems that must be Year 2000 compliant, a disruption in
their
48
businesses may result in potentially significant financial difficulties that
could affect their creditworthiness. The Corporation is assessing any
adjustments to allowance for loan losses that may be necessary to reflect the
Year 2000 issue on creditworthiness. The Corporation is also implementing
underwriting procedures to reflect the importance of the Year 2000 issue and is
evaluating new credit relationships. The Corporation is also initiating contact
with key suppliers to determine their plan with respect to the Year 2000 Issue.
There can be no guarantee that customers and suppliers will convert their
systems on a timely basis or in a manner that is compatible with the
Corporation's systems. Significant business interruptions or failures by key
business customers, suppliers, trading partners or governmental agencies
resulting from the effects of the Year 2000 Issue could have a material adverse
effect on the Corporation.
Year 2000 Costs
Since the Corporation relies on third party vendors for substantially
all of its IT systems, the expected cost to the Corporation of the Year 2000
project is not expected to exceed $500,000. Included in this amount are costs
for hardware, software and facilities upgrades, customer communications,
testing, and other direct, incremental costs required to pursue the Action
Plan. Not included in this estimate are the indirect costs associated with the
involvement of existing employees in daily Year 2000 Action Plan activities, an
amount which has not been quantified by management. All remediation costs will
be expensed in the period incurred and will be funded through normal operating
cash flow. Year 2000 project costs during the nine months ended September 30,
1998 and through the date of this filing were not material.
Risks of Year 2000 Issues
The Year 2000 issue is widespread throughout the entire global
economy, potentially affecting almost every company with any dependence on
information technology. The Corporation has attempted to assess the risk to the
Corporation of the most reasonably likely worst case scenarios involving Year
2000 noncompliance on the part of the Corporation or entities with which it
does significant business. Such risks generally fall into one of two
categories: internal risk, or the risk that the Corporation's IT and/or non-IT
systems will fail and will have a material impact on the Corporation's
financial condition or results of operations, and external risk, or the risk
that the IT or non-IT systems of parties external to the Corporation will fail,
resulting in a material impact on the Corporation's financial condition or
results of operations. In the opinion of management of the Corporation, the
internal risk of Year 2000 non-compliance, in a reasonable worst case scenario,
could involve the inability to perform certain routine customer transactions
for a period of time during 2000. In the opinion of management of the
Corporation, the external risk of Year 2000 non-compliance, in a reasonable
worst case scenario, could involve either (i) credit losses arising from
borrowers inability to perform under the terms of their loan agreements due to
Year 2000-related problems having a material impact on their cash flows, or
(ii) the inability to perform certain routine customer transactions due to the
Year 2000 non-compliance of parties external to the Corporation (e.g., utility
or communications vendors). To mitigate these risks, the Corporation has
performed Contingency Planning.
The costs of the Year 2000 project and the schedule for achieving Year
2000 compliance are based on management's best estimates, which were derived
using numerous assumptions of future events such as the availability of certain
resources (including internal and external resources (including appropriately
trained personnel), third-party vendor plans and other factors). However, there
can be no guarantee that these estimates will be achieved at the cost disclosed
or within the timeframes indicated, and actual results could differ materially
from these plans.
49
Contingency Planning
Contingency plans are being developed to mitigate the potential
effects of a disruption in normal business operations. Contingency planning
includes developing alternative solutions should a vendor not become compliant,
as well as plans for the resumption of business if, despite the Corporation's
best efforts, a business operation disruption occurs. The Corporation will have
a detailed business resumption contingency plan by March 31, 1999.
LEGAL PROCEEDINGS
In June 1995, a lawsuit was initiated against Home Federal by a
borrower's affiliated companies in which the plaintiffs alleged that Home
Federal wrongfully set-off certain funds in an account being held and
maintained by Home Federal. In addition, the plaintiffs alleged that as a
result of the wrongful set-off, Home Federal wrongfully dishonored a check in
the amount of $270,000. Plaintiffs further alleged that the actions on behalf
of Home Federal constituted unfair and deceptive trade practices, thereby
entitling plaintiffs to recover treble damages and attorneys' fees. Home
Federal denied any wrongdoing and filed a motion for summary judgment. Upon
consideration of the motion, the United States Bankruptcy Judge entered a
Recommended Order Granting Summary Judgement, recommending the dismissal of all
claims asserted against Home Federal. In October 1997, the United States
District Court entered an order granting summary judgment in favor of Home
Federal. The plaintiff has appealed the order of summary judgment and the case
is presently pending in the Fourth Circuit Court of Appeals.
In December 1996, Home Federal filed a suit against the borrower and
his company and against the borrower's wife, daughters, and a company owned by
his wife and daughter, alleging transfers of assets to the wife, daughter, and
their company in fraud of creditors, and asking that the fraudulent transfers
be set aside. The objective of the lawsuit is to recover assets which may be
used to satisfy a portion of the judgments obtained in favor of Home Federal
prior to litigation. The borrower's wife filed a counterclaim against Home
Federal alleging that she borrowed $750,000 from another financial institution,
secured by a deed of trust on her principal residence, the proceeds of which
were paid to Home Federal for application on a debt owed by one of her
husband's corporations, claiming that officers of Home Federal promised to
resume making loans to her husband's corporation after the payment. Home
Federal and its officers vigorously deny all of her allegations. Home Federal
filed a motion for summary judgment and dismissal of the counterclaim. The
motion for summary judgment was heard in the Superior Court division of the
Mecklenburg County General Court of Justice in April 1998; however, an order
has not been entered. In June 1998, Home Federal removed this case to the
United States Bankruptcy Court for the Western District of North Carolina,
Charlotte Division, due to the fact that the defendant was the debtor in a
pending bankruptcy case. Home Federal believes it has strong defenses to the
defendant's counterclaim.
In February 1997, two companies affiliated with those referred to in
the first paragraph above filed an additional action against two executive
officers of Home Federal and against an officer of another financial
institution. The action was removed from the state court to the United States
Bankruptcy Court for the Western District of North Carolina. At the same time,
the borrower, who is affiliated with all of these companies, also filed an
action in the Superior Court of Mecklenburg County, North Carolina against the
two executive officers of Home Federal and against an officer of another
financial institution. The
50
Complaints in both actions assert virtually identical claims. The plaintiffs in
both lawsuits allege that the officers of both financial institutions engaged
in a conspiracy to wrongfully declare loans to be in default so as to eliminate
those companies as borrowers of Home Federal. Plaintiffs claim actual damages,
treble damages, and punitive damages together with interest, attorneys' fees,
and other costs. Plaintiffs allege misrepresentation, breach of fiduciary duty,
constructive fraud, interference with business expectancy, wrongful bank
account set-off, and unfair and deceptive acts and practices. The action
pending in the bankruptcy court has been stayed. All defendants filed motions
for summary judgment in the state court action which were granted, and that
lawsuit was dismissed in January 1998 by the Superior Court of Mecklenburg
County. The plaintiff appealed the order granting summary judgment to the North
Carolina Court of Appeals. In July 1998, the defendants removed the state court
case to the United States Bankruptcy Court for the Western District of North
Carolina, Charlotte Division, due to the fact that the plaintiff was a debtor
in a pending bankruptcy case. As a result of the removal, the North Carolina
Court of Appeals entered an order staying further proceedings in the North
Carolina Court of Appeals in August 1998. Home Federal has agreed to indemnify
both of its officers with respect to costs, expense, and liability which might
arise in connection with both of these cases.
In July 1997, the above borrower and affiliated companies filed an
additional action against HFNC, Home Federal, and the other financial
institution referred to in the paragraph above, alleging that previous
judgments in favor of Home Federal and the other financial institution obtained
in prior litigation were obtained by the perpetration of fraud on the
Bankruptcy Court, U.S. District Court, and the Fourth Circuit Court of Appeals.
The plaintiffs are seeking to have the judgments set aside on that basis. All
defendants filed motions for summary judgment and dismissal which were granted,
and the lawsuit was dismissed on September 24, 1998. The borrower,
individually, has appealed the Order dismissing the lawsuit to the Fourth
Circuit Court of Appeals. That appeal is pending.
Management continues to deny any liability in the above-described
cases and continues to vigorously defend against the claims. However, there can
be no assurance of the ultimate outcome of the litigation, or the range of
potential loss, if any.
The Corporation and the Banks are defendants in certain other claims
and legal actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these other matters is not expected to have a material adverse effect on the
consolidated operations, liquidity or financial position of the Corporation or
the Banks.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The foregoing discussion contains certain forward-looking statements
about the Corporation's financial condition and results of operations, which
are subject to certain risks and uncertainties that could cause actual results
to differ materially from those reflected in the forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's judgment only as of the date hereof. The
Corporation undertakes no obligation to publicly revise these forward-looking
statements to reflect events and circumstances that arise after the date
hereof.
Factors that may cause actual results to differ materially from these
forward-looking statements include, but are not limited to, the passage of
unforeseen state or federal legislation or regulation applicable to the
51
Corporation's operations, the Corporation's ability to accurately predict the
adequacy of the loan loss allowance needs using its present risk grading
system, the ability to generate liquidity if necessary to meet loan demand, the
ability to manage unforeseen domestic and global rapid changes in interest
rates, the reliance on third party vendors to become Year 2000 compliant and,
with respect to the mergers with CSB and Home Federal, the inability of the
Corporation to consolidate the operations of these banks with the Corporation
in an efficient manner.
52
Statistical Information
The following tables present certain statistical information relating to the
Corporation. The tables should be read in conjunction with the Corporations's
Supplemental Consolidated Financial Statements and Notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations, both of which are included herein. All historical financial data for
the periods prior to the respective dates of the mergers with Union, CSB, and
Home Federal (each of which was accounted for as a pooling of interest) has been
restated to combine the accounts of Union, CSB and Home Federal with those of
the Company.
The following table includes for the years ended December 31, 1997, 1996, and
1995 interest income on interest earning assets and related average yields, as
well as interest expense on interest bearing liabilities and related average
rates paid. In addition, the table includes the average net yield on average
earning assets. Average balances were calculated based on daily averages.
Table 1
Average Balances and Net Interest Income Analysis
1997 1996 1995
--------------------------- ---------------------------- --------------------------
(Dollars in thousands) Interest Average Interest Average Interest Average
Average Income/ Yield/Rate Average Income/ Yield/Rate Average Income/ Yield/Rate
Balance Expense Paid Balance Expense Paid Balance Expense Paid
------- ------- ---- ------- ------- ---- ------- ------- ----
Interest earning assets:
Loans (1) (2) $1,143,175 $100,921 8.83% $1,022,119 $ 90,545 8.86% $ 833,640 $76,913 9.23%
Securities available for
sale - taxable 246,937 15,717 6.36 304,922 19,721 6.47 204,198 12,905 6.32
Securities available for
sale - nontaxable (3) 72,468 5,754 7.94 64,511 5,214 8.08 6,421 491 7.65
Investment securities held
to maturity - taxable 13,375 766 5.73 12,093 707 5.85 46,779 2,852 6.10
Investment securities held
to maturity - nontaxable(3) 1,251 83 6.63 -- -- -- 39,807 3,398 8.54
Federal funds sold 18,238 1,012 5.55 20,013 1,102 5.51 52,690 2,557 4.85
Interest-bearing bank
deposits 13,835 795 5.75 13,642 908 6.66 12,717 608 4.78
---------- -------- ---------- -------- ---------- -------
Total $1,509,279 $125,048 8.29% $1,437,300 $118,197 8.22% $1,196,252 $99,724 8.34%
========== ======== ========== ======== ========== =======
Interest bearing liabilities:
Demand deposits $ 104,514 $ 2,054 1.97% $ 97,181 $ 2,016 2.07% $ 98,470 $ 2,189 2.22%
Money market accounts 86,215 3,290 3.82 77,606 2,245 2.89 87,294 2,554 2.93
Savings deposits 132,615 5,520 4.16 134,636 6,239 4.63 125,014 5,695 4.56
Other time deposits 611,038 35,468 5.80 585,536 34,208 5.84 585,042 35,261 6.03
Other borrowings 283,167 16,495 5.83 218,815 12,708 5.81 40,652 2,145 5.28
---------- -------- ---------- -------- ---------- -------
Total $1,217,549 $ 62,827 5.16% $1,122,225 $ 57,416 5.16% $ 936,472 $47,844 5.11%
========== ======== ========== ======== ========== =======
Net interest income and
spread $ 62,221 3.13% $ 60,781 3.06% $51,880 3.23%
======== ======== =======
Net yield on interest
earning assets (4) 4.12% 4.23% 4.34%
(1) The preceding analysis takes into consideration the principal amount of
nonaccruing loans and only income actually collected on such loans.
(2) Loans are shown net of unearned income.
(3) Yields on nontaxable securities are stated on a fully taxable equivalent
basis, assuming a Federal tax rate of 35% for 1997, 1996 and 1995. The
adjustments made to convert to a fully taxable equivalent basis were
$1,918,000 for 1997, $1,826,000 for 1996 and $1,515,000 for 1995.
(4) Represents net interest income as a percentage of total average interest
earning assets.
53
Changes in Interest Income and Expense
The following table contains the dollar amount of change in interest income
and interest expense and segregates the dollar amount of change due to rate and
volume variances for the years ended December 31, 1997 and 1996. The change in
interest income, stated on a tax equivalent basis, or interest expense
attributable to the combination of rate variance and volume variance is included
in the table, but such amount has also been allocated between, and included in
the amounts shown as, changes due to rate and changes due to volume. The
allocation of the change due to rate/volume variance was made equally to rate
variance and to volume variance. Interest income related to tax exempt
securities is stated on a tax equivalent basis using a Federal income tax rate
of 35% in 1997, 1996 and 1995.
Table 2
Volume and Rate Variance Analysis
(Dollars in thousands) From Dec. 31, 1996 to Dec. 31, 1997 From Dec. 31, 1995 to Dec. 31, 1996
--------------------------------------- -------------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Change in Due to Change in
Rate/ Total Rate/ Total
Volume Rate Volume Change Volume Rate Volume Change
------ ---- ------ ------ ------ ---- ------ ------
Interest income:
Loans $(37) $(311) $ 10,724 $ 10,376 $ (693) $(3,065) $ 17,390 $ 13,632
Securities available for
sale - taxable 60 (313) (3,751) (4,004) 149 302 6,365 6,816
Securities available for
sale - non-taxable (11) (92) 643 540 253 28 4,442 4,723
Investment securities held to
maturity - taxable (2) (14) 75 59 87 (117) (2,115) (2,145)
Investment securities held to
maturity - nontaxable -- 42 41 83 -- (1,699) (1,699) (3,398)
---- ----- -------- -------- ------- ------- -------- --------
Total securities 10 (688) 7,732 7,054 (204) (4,551) 24,383 19,628
Federal funds sold (1) 8 (97) (90) (214) 344 (1,585) (1,455)
Interest bearing bank deposits (2) (124) 13 (113) 17 238 45 300
---- ----- -------- -------- ------- ------- -------- --------
Total interest income 7 (804) 7,648 6,851 (401) (3,969) 22,843 18,473
---- ----- -------- -------- ------- ------- -------- --------
Interest expense:
Demand deposits (8) (106) 152 38 2 146 (29) (173)
Money market accounts 79 716 250 1,045 3 (29) (283) (309)
Savings deposits 10 (635) (94) (719) 8 98 438 544
Other time deposits (10) (220) 1,490 1,260 (1) (1,082) 30 (1,053)
Other borrowings 11 38 3,738 3,787 946 216 9,401 10,563
---- ----- -------- -------- ------- ------- -------- --------
Total interest expense 82 (207) 5,536 5,411 958 (943) 9,557 9,572
---- ----- -------- -------- ------- ------- -------- --------
Net interest income $(75) $(597) $ 2,112 $ 1,440 $(1,359) $(3,026) $ 13,286 $ 8,901
==== ===== ======== ======== ======= ======= ======== ========
54
Interest Rate Sensitivity
The following table presents the Company's interest sensitivity analysis for
December 31, 1997 and sets forth at various maturity periods the cumulative
interest sensitivity gap, which is the difference between rate sensitive assets
and rate sensitive liabilities for assets and liabilities that management
considers rate sensitive. The mortgage-backed securities are shown at their
weighted average expected life obtained from an outside evaluation of the
average remaining life of each security based on historic prepayment speeds of
the underlying mortgages at December 31, 1997. Demand deposits, money market
accounts and savings deposits are presented in the earliest repricing window
because the rates are subject to immediate repricing.
Table 3
Non-
Interest Rate Sensitivity Sensitive
As of December 31, 1997 and
Interest Sensitivity in Days Sensitive
(Dollars in thousands) ------------------------------------------------ Over 5
1 - 90 91 - 180 181 - 365 Total 1-2 Years 2-5 Years Years Total
---------------------------------------------------------------------------------------------------
Interest-Earning Assets
Interest-bearing due
from banks $ 15,143 $ -- $ -- $ 15,143 $ -- $ -- $ -- $ 15,143
Fed funds sold 8,195 -- -- 8,195 -- -- -- 8,195
Securities available
for sale, at
amortized cost:
Taxable 22,248 420 5,445 28,113 35,956 45,167 113,496 222,732
Nontaxable 1,170 1,224 101 2,495 7,475 14,688 59,138 83,796
Loans 274,740 26,658 110,358 411,756 178,492 337,945 333,298 1,261,491
--------- --------- --------- --------- --------- --------- -------- ----------
Total earning assets 321,496 28,302 115,904 465,702 221,923 397,800 506,205 1,591,630
--------- --------- --------- --------- --------- --------- -------- ----------
Interest-Bearing Liabilities
Interest-bearing deposits:
Demand deposits 111,566 -- -- 111,566 -- -- -- 111,566
Money market accounts 113,326 -- -- 113,326 -- -- -- 113,326
Savings deposits 18,662 3,078 16,176 37,916 48,279 -- 45,081 131,276
Other time deposits 174,279 56,396 238,211 468,886 92,531 38,669 3 600,089
Other borrowings 111,200 -- 108,000 219,200 260 1,143 129,476 350,079
--------- --------- --------- --------- --------- --------- -------- ----------
Total interest-bearing
liabilities 529,033 59,474 362,387 950,894 141,070 39,812 174,560 1,306,336
--------- --------- --------- --------- --------- --------- -------- ----------
Interest sensitivity
gap $(207,537) $ (31,172) $(246,483) $(485,192) $ 80,853 $ 357,988 331,645 285,294
========= ========= ========= ========= ========= ========= ======== ==========
Cumulative gap $(207,537) $(238,709) $(485,192) $(485,192) $(404,339) $ (46,351) 285,294 285,294
========= ========= ========= ========= ========= ========= ======== ==========
Ratio of earning assets
to interest-bearing
liabilities 60.77% 47.59% 31.98% 48.98% 157.31% 999.20%
55
Distribution of Assets and Liabilities
The following table shows the distribution of the Company's assets,
liabilities and shareholders' equity at December 31, 1997, 1996, and 1995.
Average balances were calculated based on daily averages.
Table 4
Average Balance Sheet
Years Ended December 31,
----------------------------------------------------------------------------------
1997 1996 1995
------------------------- -------------------------- ---------------------------
(Dollars in thousands) Average Percentage Average Percentage Average Percentage
Balance Distribution Balance Distribution Balance Distribution
------- ------------ ------- ------------ ------- ------------
Assets:
Cash and due from banks $ 25,224 1.6% $ 24,650 1.6% $ 28,677 2.3%
Interest bearing bank deposits 13,835 0.9 13,642 0.9 12,717 1.0
Investment securities - taxable 13,375 0.8 238,074 15.8 165,848 13.2
Investment securities - nontaxable 1,251 0.1 -- -- 39,807 3.1
Securities available for sale
- taxable 246,937 15.6 78,941 5.3 85,129 6.7
Securities available for sale
- nontaxable 72,468 4.6 64,511 4.3 6,421 0.5
Loans, net (1) 1,135,909 71.6 1,015,634 67.6 827,788 65.8
Federal funds sold 18,238 1.1 20,013 1.3 52,690 4.2
Other assets 58,194 3.7 47,578 3.2 39,743 3.2
---------- ----- ---------- ----- ---------- -----
Total $1,585,431 100.0% $1,503,043 100.0% $1,258,820 100.0%
========== ===== ========== ===== ========== =====
Liabilities and shareholders' equity
Deposits:
Demand (2) $ 189,807 12.0% $ 177,550 11.8% $ 169,809 13.5%
Savings 132,615 8.4 134,636 8.9 125,014 9.9
Insured money market 86,215 5.4 77,606 5.2 87,294 6.9
Time 611,038 38.5 585,536 39.0 585,042 46.5
Other borrowings 283,167 17.9 218,815 14.6 40,652 3.2
Other liabilities 25,874 1.6 27,646 1.8 23,395 1.9
Shareholders' equity 256,715 16.2 281,254 18.7 227,614 18.1
---------- ----- ---------- ----- ---------- -----
Total $1,585,431 100.0% $1,503,043 100.0% $1,258,820 100.0%
========== ===== ========== ===== ========== =====
(l) Loans, net is net of unearned income and the allowance for loan losses.
(2) Demand includes non-interest bearing and interest bearing demand deposits.
56
Securities Available for Sale
The following table shows, as of December 31, 1997, 1996 and 1995, the
carrying value of (i) U.S. Government obligations, (ii) U.S. Government agency
obligations, (iii) mortgage-backed securities, (iv) state and municipal
obligations, and (v) equity securities.
Table 5
Securities Available for Sale
(Dollars in thousands) December 31,
------------------------------------
1997 1996 1995
---- ---- ----
U.S. Government obligations $ 22,333 $ 39,095 $ 41,964
U.S. Government agency obligations 120,739 125,844 146,327
Mortgage-backed securities 59,548 67,711 141,376
State and municipal obligations 85,532 72,050 59,053
Equity securities 27,413 21,125 10,974
-------- -------- --------
$315,565 $325,825 $399,694
======== ======== ========
Investment Securities Held to Maturity
The following table shows, as of December 31, 1997, 1996 and 1995, the
amortized cost (face amount, plus unamortized premiums, less unamortized
discounts), of U.S. Government obligations, included in investment securities
held to maturity.
Table 6
Investment Securities
Held to Maturity
(Dollars in thousands) December 31,
-----------------------------
1997 1996 1995
---- ---- ----
U.S. Government obligations $-- $13,940 $8,959
--- ------- ------
$-- $13,940 $8,959
=== ======= ======
57
Securities Available for Sale - Maturities
The following table indicates the carrying value of each significant
securities available for sale category due within one year, after one year but
within five years, after five years but within ten years, and after ten years,
together with the weighted average yield for each range of maturities, as of
December 31, 1997. Mortgage-backed securities are presented at their contractual
maturity date. Actual maturities will differ from contractual maturities because
borrowers have the right to pre-pay these obligations without pre-payment
penalties. Yields are determined based on amortized cost. Yields are stated on a
tax equivalent basis assuming a Federal income tax rate of 35% in 1997.
Table 7
Securities Available for Sale
As of December 31, 1997
(Dollars in thousands)
After Five
Due Within One After One Year but Years But
Year Within Five Years Within Ten Years After Ten Years
----------------- ------------------ ----------------- ------------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
U.S. Government
Obligations $10,016 6.68% $12,317 7.47% $ -- --% $ -- --%
U.S. Government
Agency Obligations 2,791 5.57 52,928 6.55 37,200 7.17 27,820 7.26
Mortgage-Backed
Securities 504 5.40 2,641 6.68 4,649 6.07 51,754 7.46
State & Municipal
Obligations 2,504 9.43 24,035 8.02 37,665 7.06 21,328 7.33
Equity securities 13,786 5.97 -- -- -- -- 13,627 5.46
------- ------- ------- --------
Total $29,601 6.46% $91,921 7.06% $79,514 7.05% $114,529 7.15%
======= ==== ======= ==== ======= ==== ======== ====
As of December 31, 1997, there were no issues of securities available for
sale (excluding U.S. Government obligations and U.S. Government agency
obligations) which had carrying values that exceeded 10% of shareholders' equity
of the Company.
As of December 31, 1997, there were no investment securities classified as
held to maturity.
58
Loan Portfolio
The table below summarizes loans in the classifications indicated as of
December 31, 1997, 1996, 1995, 1994, and 1993.
Table 8
Loan Portfolio Composition
(Dollars in thousands) December 31,
-----------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- --------- --------- ---------
Commercial, financial and
agricultural $ 80,675 $ 63,686 $ 66,944 $ 61,054 $ 55,981
Real estate - construction
and development 133,303 102,460 84,591 69,974 74,014
Real estate - mortgage 964,537 869,255 701,376 596,094 550,402
Installment 88,546 92,567 79,888 74,096 64,854
----------- ----------- --------- --------- ---------
Total loans 1,267,061 1,127,968 932,799 801,218 745,251
----------- ----------- --------- --------- ---------
Less - allowance for loan
losses (15,263) (14,140) (13,552) (13,144) (12,433)
Unearned income (5,570) (5,517) (5,355) (5,654) (6,688)
----------- ----------- --------- --------- ---------
Loans, net $ 1,246,228 $ 1,108,311 $ 913,892 $ 782,420 $ 726,130
=========== =========== ========= ========= =========
59
Maturities and Sensitivities of Loans to Change in Interest Rates
Set forth in the table below are the amounts of each loan type, except
installment loans and real estate mortgage loans, due in one year, after one
year through five years, and after five years, at December 31, 1997. This table
excludes nonaccrual loans.
Table 9
Maturities and Sensitivity to
Change in Interest Rates
December 31, 1997
----------------------------------------------------------
(Dollars in thousands) After l
l year Year through After
or less 5 Years 5 Years Total
------- ------- ------- -----
Commercial, financial
and agricultural $36,317 $ 31,919 $12,439 $ 80,675
Real estate
construction and
development 61,805 71,262 236 133,303
------- -------- ------- --------
Total $98,122 $103,181 $12,675 $213,978
======= ======== ======= ========
The amounts of the above loans with a maturity over one year which have a
predetermined interest rate or a floating or adjustable interest rate are as
follows:
December 31, 1997
--------------------
(Dollars in thousands)
Predetermined interest rate $83,766
Floating or adjustable interest rate 32,090
60
Non-performing Loans
Non-performing loans includes non-accrual loans, re-structured loans and
accruing loans which are contractually past due 90 days or more.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Balance Sheet Analysis - Asset Quality" for additional
information.
Accruing Loans 90 Days or More Past Due
The following table reflects the dollar amount of loans outstanding in each
category and the amount and percentage of those accruing loans which are 90 days
or more past due as of December 31, 1997, 1996, 1995, 1994, and 1993.
Table 10
Accruing Loans 90 Days or More Past Due
Accruing Percentage of
Loans 90 Such Loans to
Days or Gross Gross Loans
(Dollars in thousands) More Loans Outstanding
Past Due Outstanding By Category
-------- ----------- -----------
December 31, 1997
Commercial, financial and
agricultural $ 999 $ 80,675 1.24%
Real estate - construction
and development 33 133,303 .02
Real estate - mortgage 858 964,537 .09
Installment 219 88,546 .25
------ ----------
Total $2,109 $1,267,061 .17%
====== ==========
December 31, 1996
Commercial, financial and
agricultural $ 34 $ 63,686 .05%
Real estate - construction
and development 49 102,460 .05
Real estate - mortgage 469 869,255 .05
Installment 133 92,567 .14
------ ----------
Total $ 685 $1,127,968 .06%
====== ==========
December 31, 1995
Commercial, financial and
agricultural $ 27 $ 66,944 .04%
Real estate - construction
and development 47 84,591 .06
Real estate - mortgage 163 701,376 .02
Installment 164 79,888 .21
------ ----------
Total $ 401 $ 932,799 .04%
====== ==========
December 31, 1994
Commercial, financial and
agricultural $ 219 $ 61,054 .36%
Real estate - construction
and development -- 69,974 --
Real Estate - mortgage 1,109 596,094 .19
Installment 224 74,096 .30
------ ----------
Total $1,552 $ 801,218 .19%
====== ==========
Table 10 is continued on next page
61
Table 10 (Continued)
Accruing Loans 90 Days or More Past Due
Accruing Percentage of
Loans 90 Such Loans to
Days or Gross Gross Loans
(Dollars in thousands) More Loans Outstanding
Past Due Outstanding By Category
-------- ----------- -----------
December 31, 1993
Commercial, financial and
agricultural $ 110 $ 55,981 .20%
Real estate - construction
and development -- 74,014 --
Real estate - mortgage 198 550,402 .04
Installment 82 64,854 .13
------ ----------
Total $ 390 $ 745,251 .05%
====== ==========
Non-Accrual Loans and Restructured Loans
The determination to discontinue the accrual of interest is based on a
review of each loan. Interest is discontinued on loans 90 days past due as to
principal or interest unless in management's opinion collection of both
principal and interest is assured by way of collateralization, guarantees or
other security and the loan is in the process of collection. The table below
summarizes the Company's non-accrual loans and restructured loans as of the
dates indicated.
Table 11
Non-accrual and Restructured Loans
December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------- ------- -------
(Dollars in thousands)
Non-accrual loans
Principal balance outstanding $6,119 $7,949 $10,497 $11,258 $19,894
====== ====== ======= ======= =======
Interest income recorded during
the year $ 383 $ 154 $ 267 $ 386 $ 635
Interest income that would have
been recorded if the loans had
been current and accruing $ 339 $ 646 $ 1,120 $ 1,407 $ 2,070
Restructured loans
Principal balance outstanding $ 587 $ 643 $ 825 $ 2,747 $ 2,003
====== ====== ======= ======= =======
Interest income recorded during
the year $ 66 $ 61 $ 95 $ 230 $ 165
Interest income that would have
been recorded if the loans had
been current and accruing $ 66 $ 61 $ 77 $ 266 $ 174
62
Summary of Loan Loss and Recovery Experience
The table below presents certain data for the years ended December 31,
1997, 1996, 1995, 1994, and 1993, including the following: (i) the average
amount of net loans outstanding during the year, (ii) the allowance for loan
losses at the beginning of the year, (iii) the provision for loan losses, (iv)
loans charged off and recoveries of loans previously charged off presented by
major loan categories, (v) loan charge-offs, net, (vi) the allowance for loan
losses at the end of the year, (vii) the ratio of net charge-offs to average
loans, (viii) the ratio of the allowance for loan losses to average loans and
(ix) the ratio of the allowance for loan losses to loans at year-end, excluding
loans held for sale.
Table 12
Summary of Loan Loss and Recovery Experience
(Dollars in thousands) Years Ended December 31,
------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- -------- -------- --------
Average loans, net of unearned
income $1,143,175 $1,022,119 $833,640 $758,639 $736,369
========== ========== ======== ======== ========
Allowance for loan losses:
Beginning balance $ 14,140 $ 13,552 $ 13,144 $ 12,433 $ 11,543
Add provision for loan losses 2,684 1,481 2,328 1,591 2,485
---------- ---------- -------- -------- --------
16,824 15,033 15,472 14,024 14,028
---------- ---------- -------- -------- --------
Loan charge-offs:
Commercial, financial and
agricultural 712 600 1,599 770 840
Real estate - construction
and development -- -- 349 148 --
Real estate - mortgage 251 111 212 147 454
Installment 1,298 1,099 539 412 487
---------- ---------- -------- -------- --------
2,261 1,810 2,699 1,477 1,781
---------- ---------- -------- -------- --------
Recoveries of loans previously
charged-off:
Commercial, financial and
agricultural 135 654 58 272 84
Real estate - construction
and development -- 3 25 1 --
Real estate - mortgage 44 27 3 190 19
Installment 252 233 693 63 83
---------- ---------- -------- -------- --------
431 917 779 526 186
---------- ---------- -------- -------- --------
Loan charge-offs, net 1,830 893 1,920 951 1,595
---------- ---------- -------- -------- --------
Adjustment for merged banks 269 -- -- 71 --
---------- ---------- -------- -------- --------
Ending balance $ 15,263 $ 14,140 $ 13,552 $ 13,144 $ 12,433
========== ========== ======== ======== ========
Net charge-offs to average loans .16% .09% .23% .13% .22%
Allowance for loan losses to
gross loans at year-end 1.20 1.25 1.45 1.64 1.67
For a discussion of management's evaluation of the allowance for loan
loss, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Earnings Performance - Provision for Loan Losses" and
"-Balance Sheet Analysis - Asset Quality" in the First Charter Corporation 1997
Annual Report to Shareholders, incorporated herein by reference.
63
Allowance for Loan Losses
The following table presents the dollar amount of the allowance for loan losses
applicable to major loan categories (including pro rata share of unallocated
reserves), the percentage of the allowance amount in each category to the total
allowance and the percentage of the loans in each category to total loans as of
December 31, 1997, 1996, 1995, 1994, and 1993. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Earnings Performance
- - Provision for Loan Losses" and "- Balance Sheet Analysis - Asset Quality" in
the First Charter Corporation 1997 Annual Report to Shareholders, incorporated
herein by reference.
Table 13
Allowance for Loan Losses
Percentage of
(Dollars in thousands) Percentage Gross Loans in
Allowance of Total Each Category
Amount Allowance to Total Loans
--------- ---------- --------------
December 31, 1997
Type of Loan:
Commercial, financial and
agricultural $ 1,664 11% 6%
Real estate - construction and
development 2,422 16 11
Real estate - mortgage 10,023 66 76
Installment 1,154 7 7
------- --- ---
Total $15,263 100% 100%
======= === ===
December 31, 1996
Type of Loan:
Commercial, financial and
agricultural $ 1,329 9% 6%
Real estate - construction and
development 3,117 22 9
Real estate - mortgage 8,869 63 77
Installment 825 6 8
------- --- ---
Total $14,140 100% 100%
======= === ===
December 31, 1995
Type of Loan:
Commercial, financial and
agricultural $ 936 7% 7%
Real estate - construction and
development 3,839 28 9
Real estate - mortgage 7,851 58 75
Installment 926 7 9
------- --- ---
Total $13,552 100% 100%
======= === ===
Table 13 is continued on page 21.
64
Table 13
Allowance for Loan Losses (Continued)
(Dollars in thousands) Percentage of
Percentage Gross Loans in
Allowance of Total Each Category
Amount Allowance to Total Loans
--------- --------- ---------------
December 31, 1994
Type of Loan:
Commercial, financial and
agricultural $ 1,516 12% 8%
Real estate - construction and
development 3,970 30 13
Real estate - mortgage 6,608 50 70
Installment 1,050 8 9
------- --- ---
Total $13,144 100% 100%
======= === ===
December 31, 1993
Type of Loan:
Commercial, financial and
agricultural $ 1,902 15% 8%
Real estate - construction and
development 4,770 39 9
Real estate - mortgage 4,863 39 74
Installment 898 7 9
------- --- ---
Total $12,433 100% 100%
======= === ===
65
Deposits
The Banks primarily serve individuals and small- to medium-sized businesses with
a variety of deposit accounts, such as NOW accounts, money market accounts,
certificates of deposit and individual retirement accounts. The following table
presents average balances by category and average rates paid for the years ended
December 31, 1997, 1996, and 1995. Average balances were calculated based on
daily averages.
Table 14
Deposits
As of December 31,
------------------------------
1997 1996 1995
------------------------------- ------------------------------ --------------------------
Avg. Avg. Avg.
(Dollars in thousands) Average Interest Rate Average Interest Rate Average Interest Rate
Balance Expense Paid Balance Expense Paid Balance Expense Paid
---------- -------- ---- -------- -------- ---- -------- -------- ----
Non-interest bearing demand
deposits $ 93,763 $ -- -- $ 88,820 $ -- -- $ 78,904 $ -- --
Interest bearing deposits:
Demand deposits 104,514 2,054 1.97% 97,181 2,016 2.07% 98,470 2,189 2.22%
Insured money markets 86,215 3,290 3.82 77,606 2,245 2.89 87,294 2,554 2.93
Savings deposits 132,615 5,520 4.16 134,636 6,239 4.63 125,014 5,695 4.56
Time deposits 611,038 35,468 5.80 585,536 34,208 5.84 585,042 35,261 6.03
---------- ------- -------- ------- -------- --------
Total $ 934,382 $46,332 $894,959 $ 44,708 $895,820 $ 45,699
---------- ------- -------- ------- -------- --------
Total deposits $1,028,145 $46,332 $983,779 $ 44,708 $974,724 $ 45,699
========== ======= ======== ======== ======== ========
As of December 31, 1997, domestic time deposits of $100,000 or more totaled
$146,496,000, with the following maturities: $63,368,000, three months or less;
$26,779,000, over three months through six months; $27,315,000, over six months
through twelve months and $29,034,000, over one year.
66
Other Borrowings
The following is a schedule of other borrowings which consists of the
following categories: securities sold under repurchase agreements, federal funds
purchased and Federal Home Loan Bank ("FHLB") borrowings for the years ended
December 31, 1997, 1996 and 1995.
Table 15
Other Borrowings
Interest Maximum
Balance Rate Avg. Outstanding
(Dollars in thousands) as of as of Average Int. at Any
Dec. 31 Dec. 31 Balance Rate Month-End
------- -------- ------- ---- ------------
1997
Federal funds purchased,
securities sold under
agreements to purchase
and FHLB borrowings $350,079 5.59% $283,167 5.88% $413,789
======== ======== ========
1996
Federal funds purchased,
securities sold
under agreements to
repurchase and
FHLB borrowings $309,895 6.07% $218,948 5.84% $259,036
======== ======== ========
1995
Federal funds purchased,
securities sold
under agreements to
repurchase and
FHLB borrowings $124,714 5.47% $ 40,568 5.27% $ 87,420
======== ======== ========
At December 31, 1997, the Banks had three available lines of credit with the
FHLB totaling $302.5 million with $236,933,000 outstanding. The outstanding
amounts consisted of $132,400,000 maturing in 1998, $260,417 maturing in 1999,
$1,142,858 maturing in 2001, $102,000,000 maturing in 2002, $600,000 maturing in
2003, and $530,000 maturing in 2011. At December 31, 1997, such amounts were
outstanding at market interest rates for the specific advance program and
maturity. In addition, the Banks are required to pledge collateral to secure the
advances as described in the line of credit agreements. The collateral consists
of FHLB stock and qualifying 1-4 family residential mortgage loans.
See also note 10 to Supplemental Consolidated Financial Statements.
67
Return on Equity and Assets
The table below indicates the return on average assets (net income
divided by average total assets), return on average equity (net income divided
by average equity), dividend payout ratio (dividends declared divided by net
income), and average equity to average assets ratio (average equity divided by
average total assets) and other key operating data for the years ended December
31, 1997, 1996, and 1995. Averages are based on daily balances.
Table 16
Return on Equity and Assets
December 31,
-------------------------------------------------------
1997 1996 1995
---------- ---------- -----------
(Dollars in thousands
except per share amounts)
Net income $ 19,171 $ 17,433 $ 15,878
Average shareholders' equity 256,715 281,254 227,614
Average total assets 1,585,431 1,503,043 1,258,820
Dividends per share (1) 0.53 0.50 0.43
Basic net income per share 1.06 0.95 0.95
Diluted net income per share 1.03 0.94 0.94
Return on average assets 1.21% 1.16% 1.26%
Return on average equity 7.47 6.20 6.98
Dividend payout ratio (1) 50.54* 37.49* 31.53*
Average equity to average assets ratio 16.19 18.71 18.08
*Excludes HFNC Financial information for comparison purposes.
(1) Computed using First Charter Corporation's historical dividends declared per
share. Dividends declared per share by First Charter Corporation were $0.53 per
share, $0.50 per share and $0.43 per share for the years ended December 31,
1997, 1996 and 1995, respectively. Dividends declared per share by HFNC were
$5.28 per share and $0.12 per share for the years ended December 31, 1997 and
1996, as adjusted to conform to First Charter Corporation's December 31 fiscal
year. HFNC declared no dividends during the year ended December 31, 1995.
Dividends declared per share by HFNC in the year ended December 31, 1997
includes a special distribution of $5.00 per share to HFNC shareholders,
substantially all for which was deemed to be a return of capital to
shareholders.
68
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST CHARTER CORPORATION
(Registrant)
By: /s/ Lawrence M. Kimbrough
-------------------------------------
Lawrence M. Kimbrough
President and Chief Executive Officer
By: /s/ Robert O. Bratton
-------------------------------------
Robert O. Bratton
Executive Vice President and
Chief Financial Officer
Date: January 11, 1999